Q.A trading firm's average inventory is ₹20,000 (cost). If the inventory turnover ratio is 8 times and the firm sells goods at a gross profit of 20% on sales, ascertain the gross profit of the firm.

Inventory Turnover Ratio – A First Look

Think of a kirana shop. The owner buys a carton of biscuits, keeps it on the shelf, and sells it. If that carton sits unsold for six months, the money used to buy it is stuck — it's not earning anything. But if the same carton sells out in a week and is replaced by a new one, the owner's money is working hard, turning over again and again.

That's the core idea: how fast does inventory sell? The Inventory Turnover Ratio measures exactly this speed.

The Precise Meaning

The ratio tells you how many times a business sells and replaces its entire stock of inventory during an accounting period (usually a year).

Where:

• Cost of Revenue from Operations = Opening Inventory + Purchases + Direct Expenses – Closing Inventory (this is the cost of goods sold, not the selling price)
• Average Inventory = (Opening Inventory + Closing Inventory) ÷ 2

A high ratio means inventory moves quickly — good for cash flow. A low ratio means goods sit idle — money is locked up, and there's risk of obsolescence or spoilage.

Why It Matters (The "So What?")

For a Class 12 student, this ratio is part of Turnover Ratios under Accounting Ratios (NCERT Class 12, Part B, Chapter 5). It helps answer three questions:

1. Efficiency – Is the company managing its stock well? A ratio of 8 means inventory is sold and replaced 8 times a year (roughly every 45 days).
2. Liquidity – Slow-moving inventory can signal poor sales or overstocking, which strains cash.
3. Comparison – Compare with past years or with competitors in the same industry. A textile firm and a vegetable vendor will have very different ideal ratios — context matters.

Accounting Treatment – What Gets Debited/Credited?

The ratio itself is a calculation, not a journal entry. But the numbers that feed into it come from real accounts:

• Cost of Revenue from Operations is the Trading Account's debit side (the cost of goods sold). It is not a separate ledger account — it's a derived figure.
• Inventory appears in the Balance Sheet under Current Assets. When inventory is sold, the journal entry is:

This entry reduces Inventory (credit) and increases the cost side of the Trading Account (debit). The ratio then uses the average of opening and closing Inventory balances.

Format / Proforma (as per NCERT)

The ratio is presented in the Comparative Statement or Common Size Statement format. Here's the standard proforma for calculating it: