No. of Recommendations: 0
I am a little confused on the inventory turnover formula. According to the Motley Fool Investment Workbook, inventory turnover is computed by dividing sales by inventory. However, most financial books recommend dividing cost of sales by inventory. I am reposting a message from the Motley Fool Inv. Workbook board that addresses this very issue:

<<In chap 8, it's mentioned to divide inventory into the revenue, however, shouldn't it be divided
into the cost of sales??? It seems to me the latter would be a conservative position, since the
product(s) haven't been sold yet and the only cost tagged on it is the labor and material cost to
produce it. Once sold, though, it seems logical the product(s) cost would either escalate or
decrease the revenues.>>

Cost of Sales or Cost of Goods Sold divided by inventory is not used because in it is a fixed cost
along with the variable cost. For example, Coca-Cola pays a fixed cost for its plant that brews the
syrup whether the syrup is sold or not. Also included is a variable cost, which is all that wierd
stuff they put in it eye of newt, possum tails, etc (which I think the ingredients are secret). If Coke
sold no syrup in a year and sales were zero, you would have almost the same number if you
divided the cost of goods sold by inventory as you would if they sold a lot of product, since the
fixed cost is probably the greatest.

If Coke sold no product this year, you would have 0 dollars of sale for 1 dollar of inventory,
which would be very noticeable and important.

I have read the response but don't entirely understand it. Since "sales" can arbitrarily reflect any price that the company wants to charge for its products, wouldn't this variable cause too much variation in the formula? If anyone can shed any light on this, I would most appreciative! I have recently formed an investment club and we are using the TMF Investment Workbook as our first "text". I am putting together a spreadsheet to compute the various computations and formulas and want to ensure that the formulas I'm using are accurate. Thanks!

Karen :)
Print the post  


What was Your Dumbest Investment?
Share it with us -- and learn from others' stories of flubs.
When Life Gives You Lemons
We all have had hardships and made poor decisions. The important thing is how we respond and grow. Read the story of a Fool who started from nothing, and looks to gain everything.
Contact Us
Contact Customer Service and other Fool departments here.
Work for Fools?
Winner of the Washingtonian great places to work, and Glassdoor #1 Company to Work For 2015! Have access to all of TMF's online and email products for FREE, and be paid for your contributions to TMF! Click the link and start your Fool career.