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Companies must walk a fine line between maintaining enough inventory to enable immediate sales, but without producing too many units that end up sitting in a warehouse unsold. Modern companies do their best to produce goods as needed on a just-in-time basis. So they limit their upfront investment and don't have unsold products sitting in a warehouse. The inventory turnover ratio indicates how well a company handles that problem. To calculate the inventory turnover ratio, you divide the cost of goods sold by the value of goods currently in inventory. So, I have those figures here. The cost of goods sold and the inventory, and to calculate the ratio, we divide B5, cost of goods sold, by B6, which is the inventory turnover ratio.
The inventory turnover ratio is a measure of how efficiently a company manages its production processes. One example of managing inventory is the book publishing industry. On a per unit basis, it is much less expensive to print 100,000 copies of a book than 10,000. So publishers will often order a huge run of books. So, half of them with the regular price, and offer the rest of the stores at a deep discount. This process called remaindering enables stores to purchase for $1 older books that might have been sold at a wholesale price of $10 when the book was still popular.
Selling the extra books at that deeply discounted price, removes the stock from the publisher's inventory, and improves the company's inventory turnover ratio. If you're thinking about investing in a manufacturing firm, you should compare its inventory turnover ratio to the industry average, and the ratio of other companies in the sector. A relatively high inventory turnover ratio indicates that goods are sitting in a warehouse, taking up space and depreciating.
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