In your typical business operation, turning the inventory over as often as possible has several benefits. First, it generally reduces overall costs, secondly, it generates greater profits and third, by increasing the profitability, the company has a greater return on equity. OK, this seems all well and good, but does turning the inventory over in the house flipping business as fast as possible generate the same benefits?
Explanation of Inventory Turnover
Inventory turnover refers to a relationship that exists between inventory and sales. It is simply the number of days it takes to turn over the dollar value of the inventory. This relationship is important because as a retailer, you would want this frequency as high as possible. You should not use this ratio to compare yourself to another similar store for various reasons, use it to compare yourself to the industry as a whole or to compare to past performances from the same store. It is a mere standard for internal comparison only; it is not a gauge of value. But if properly implemented and utilized, the retail store owner can maximize profits.
In business, liquidity is defined as the period of time it takes to turn assets into cash. It takes 20 minutes to turn the balance in the checking account into cash. You head on down to the bank and present a check. You get cash. But most businesses run on just more than the cash in the bank account.
A relationship exists between inventory and sales. This is referred to as ‘Inventory Turnover’ or ‘Turnover Ratio’. It is simply the number of days it takes to turn over the dollar value of the inventory. This relationship is important because as the retailer, you would want this number has high as possible.