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).
Inventory Turnover Ratio=Average InventoryCost of Revenue from Operations
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:
- 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).
- Liquidity – Slow-moving inventory can signal poor sales or overstocking, which strains cash.
- 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.
A very high ratio isn't always good. It could mean the company keeps too little stock and risks running out (stockouts), losing customers. A very low ratio could mean obsolete goods no one wants.
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:
| Date | Particulars | L.F. | Debit (₹) | Credit (₹) |
|---|
| Cost of Revenue from Operations A/c (or Trading A/c) Dr. | | XXX | |
| To Inventory A/c | | | XXX |
| (Being cost of inventory sold transferred) | | | |
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:
Format for Computing Inventory Turnover Ratio
| Particulars | Amount (₹) |
|---|
| 1. Cost of Revenue from Operations | |
| Opening Inventory | XXX |
| Add: Purchases | XXX |
| Add: Direct Expenses (e.g., carriage, wages) | XXX |
| Less: Closing Inventory | (XXX) |