The inventory-to-sales ratio is important for companies wanting to improve efficiency and earnings. This ratio provides important insights into inventory turnover and the overall health of a company's supply chain by analyzing the link between inventory levels and revenues.
Learning to balance inventory and sales with the inventory-to-sales ratio is helpful for any business owner or manager who wants to boost their company's competitive edge and profits in today's fast-paced business world.
In this article, we'll take a look at the inventory-to-sales ratio and its importance for understanding inventory efficiency.
What Is the Inventory to Sales Ratio?
The inventory-to-sale ratio evaluates a company's inventory levels in relation to the revenues it generates. The inventory-to-sale ratio compares the value of a company's inventory to the cost of making or purchasing those products. The business calculates it depending on the prices of those products.
- A low inventory-to-sales ratio shows that sales are strong and inventory is low, indicating that the business is performing well.
- On the other hand, a high inventory-to-sales ratio suggests that stock is expanding rapidly compared to the rate at which products are moving off the shelves.
Why Is the Inventory to Sales Ratio Significant?
The inventory-to-sale ratio is significant because it provides important insights into how well a business is functioning and how financially stable it is. Inventory is frequently among the largest expenditures for businesses and is a requirement for sales.
Hence the inventory-to-sales ratio is an important metric. Businesses sometimes want to sell their merchandise quickly, and knowing their inventory-to-sale ratio allows them to track their sales rate.
When Is This Ratio Useful?
The retail inventory-to-sales ratio provides important information about a company's sales strategy, inventory practices, and methods of delivering finished goods to buyers or retail outlets. A good inventory-to-sale ratio is less than one, and companies often strive for a ratio between 0.17 and 0.25.
- The closer the ratio to zero, the better it is for a business because it indicates that sales and inventory are relatively low.
- When sales exceed the inventory cost, the business will likely produce money.
- If the ratio is significantly higher than 0.25, sales are undoubtedly insufficient.
- On the other hand, an extremely low ratio may signal that inventory is selling too quickly to meet demand, in which case the business may benefit from increasing output.
A company can get a strong insight into its selling patterns by watching its ratio over three to five years.
Inventory to Sales Ratio Formula
The IS ratio can be calculated by dividing the average inventory by the net sales. A period's average stock can be calculated by adding the stock at the beginning of the period to the stock at the end and dividing it by two.
The net sales figure is the overall sales volume less the number of product returns. Income statements and balance sheets often contain the data needed to calculate these ratios. The sales-to-inventory ratio formula for an organization is as follows:
IS ratio = average inventory value / Net sales
Examples of Inventory-to-Sales Ratio Calculations
The inventory-to-sales ratio chart takes on multiple aspects depending on the industry. Looking at various instances can help with learning how to calculate the ratio. The ratio calculations for two hypothetical businesses are given below.
Example 1: Assume a company's inventory value is INR 500,000 at the beginning and INR 700,000 at the end of the month. The entire monthly sales of the company are INR 2,000,000.
(Beginning Inventory + Ending Inventory) / 2 = (500,000 + 700,000) / 2 = 1,200,000 / 2 = INR 600,000
(600,000 / 2,000,000) * 100 = 0.3 * 100 = 30%
As a result, the inventory-to-sales ratio in this case is 30%.
Example 2: A firm has an opening inventory value of INR 800,000 and a closing inventory value of INR 600,000. The period's total sales are INR 1,500,000.
Inventory Average = (800,000 + 600,000) / 2 = 1,400,000 / 2 = INR 700,000
Inventory-to-Sales Ratio = (700,000/1.5 million) * 100 = 0.4667 * 100 = 46.67%
As a result, the inventory-to-sales ratio in this case is around 46.67%.
Read Also: What Is Order Fulfillment?
How Do You Achieve the Right Inventory I/S Ratio?
With today's fast-moving, ever-changing global marketplace, where sales and shipping times are constantly changing, finding the right balance can be challenging. Sales and stock levels are affected by various factors, such as supply chain activities, past and present sales data, and marketing activities.
Considering all of these will help you determine the appropriate level of stock to keep on hand to prevent stockout or overstock. Seasonality, stockouts, and unusual events (like COVID-19) must be accounted for while compiling this data, which should be done regularly for the inventory-to-sales ratio benchmark.
Calculate the Inventory-to-Sales Ratio Efficiently With TranZact
The Inventory to sales ratio is a key indicator of how well a company manages its stock. Businesses can maximize efficiency, cut expenses, and boost cash flow by balancing stock on hand and sales results.
When the ratio is low, inventory management is strong, while when it's high, changes are required. With TranZact, businesses can increase their chances of success in a competitive market and improve their bottom line by learning to master this ratio.
FAQs on Inventory to Sales Ratio
1. How to calculate the inventory-to-sales ratio for a business?
To calculate the inventory-to-sales ratio, you need to use the following formula: Inventory to Sales = Average Inventory / Net Sales
2. What is a good inventory-to-sales ratio?
A ratio of 5-10 indicates a healthy turnover of inventories. It indicates that the company has a high turnover rate and that most of its stock has been sold.
3. Why is the inventory sales ratio a late indicator?
Inventory sales ratios reflect past events. A fast turnover lets a business estimate demand and adjust supply. If a company makes forecasting mistakes, it might be hard to improve the ratio.
4. What do high days sales in inventory mean?
High inventory days indicate overstocking and higher storage costs. It may slow the company's processes and make it hard to meet demand. If they reduce stock, revenue may decline.
5. Why is the inventory-to-sales ratio important for financial analysis?
Financial analysis needs inventory-to-sales ratio analysis to assess a company's inventory management and operations. It detects concerns, including excess inventory, stockouts, and low inventory. By tracking this ratio, businesses can optimize inventory investment, minimize expenditures, and increase profitability.
6. How does the inventory-to-sales ratio impact customer satisfaction?
Optimal inventory-to-sales ratios assure product availability. A balanced ratio lowers stockouts, allowing firms to fulfill client orders quickly and improve client satisfaction.
