Inventory turnover ratio: using DueDil for risk and investment

09 June 2015 Matt Owen

If you’re a DueDil user, you’ll already know that we let you sort through more than 3.5 million active private companies with ease. Some of the filters are fairly obvious. Currency, location, employee count. All useful for lead gen, risk management and more besides.

But as you descend down the list, some terms start to appear that you might be unfamiliar with. I have absolutely no idea what depreciation growth actually means (Don’t panic, we’ll find out in a future post), or why it’s important for me to know about gearing percentages.

I’m sure I’m not the only one in this boat, so I thought it would be good to whip through some of the filters so that you can get more value and useful information from the tool.

Let’s get started then, with…

Inventory turnover ratio

In an age of drop-shipping and SAAS this figure may be slightly less important than it once was, but if you’re doing business with anyone who carries physical goods then this can indicate a range of useful information.

What is inventory turnover ratio?

Essentially, inventory turnover ratio is an indicator of how much inventory is actually sold over a given period.

This may seem straightforward. Selling more inventory in a year is a good thing, so the higher the ratio, the better.

Let’s take a look at DueDil and see who’s managing this

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Way up at the top end, there are just nine active companies, straddling the travel, property, fund management and comms sectors (with the notable exception of Bristol Aero Collection Trust. Who would have thought that teaching kids about the history of flight would be such a gangbuster?).

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Generally speaking, this means that the people running these companies are exceptionally good at selling, or exceptionally good at managing their inventory (or indeed, both).

But it’s worth remembering that a really high ratio might not be great all the time. It’s a tricky balancing act to keep up, and you could miss out if you had an unexpectedly large order come in and couldn’t fulfil it.

Low inventory rates = too much stock being sold too slowly. High inventory ratios = Not enough stock being sold too quickly.

How is this worked out?

There’s a number of formulas for calculating Inventory Turnover Ratio, each with pros and cons.

The most straightforward is to take the market value of sales and divide it by your ending inventory.

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However, stores that keep physical goods are often subject to the whims of the seasons. Paddling pool sales tend to rise when it’s hot.

If that’s the case, it’s probably a better idea to divide your Cost of Goods Sold by an average inventory figure at this point.

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Why it matters

Obviously this can be used as a business goal. Up your inventory ratio, and you’ll (presumably) be increasing the amount of business you do, but it also matters for investors. Alongside all your usual due diligence, you could take a peek at a given company’s cost of goods sold and average inventory figures.

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If you had a cost of goods sold of £50,000 and an average inventory of £5,000, then you’d know that the business had sold its entire inventory ten times in a given period.

This would let you see how the business compared to rivals. (Of course, some inventories are supposed to sell faster than others. You can’t compare Oranges to Lamborghinis here).

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This is a good indicator of how busy a business is, and owning less stock at any given time has lots of positive knock-on effects: less rental on warehouse space for example.

Generally speaking, a higher ratio is an indicator that a business is more likely to be more profitable, more quickly. But buyer beware: too high and the whole thing could come crashing down. If you keep selling out, you risk annoying your customers.