Question

Why not use Sales in the Inventory Turnover Ratio?

Answer 1

The short answer is: Because Inventory is at cost. Inventory is not on the company's books at selling prices.

The Inventory Turnover Ratio is Cost of Goods Sold divided by average Inventory. Let's illustrate the ratio with the following amounts: Sales for the year $800,000; Cost of Goods Sold for the year $600,000; Inventory (average amount at cost during the year) $200,000. Inventory Turnover Ratio = $600,000 divided by $200,000 = 3 times. On average the inventory turned over approximately 3 times during the year.

Had we used Sales in the ratio, it would indicate that the inventory had turned over 4 times (Sales of $800,000 divided by $200,000 of Inventory), which is not the case. While some organizations do use Sales in the calculation, it is not logical to divide selling prices by cost. The resulting ratio is not reality. (Perhaps some use Sales because the Cost of Goods Sold number is not readily available for every company. In order to have comparability with all companies, they may have opted to use Sales.)

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Answer 2

There are two methods

1 Sales/inventory : This is mainly to calculate Sales efficiency

2 Cost of Goods Sold/ Average inventory: This is mainly to optimize storage option or show efficiency in working capital management

In first thrust is on higher Sales and the later one has cost savings