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Retail Business Environment

Notes more efficiently. This makes it difficult for the company to make comparisons with other
companies.
Inventory Turnover Ratio: In order to overcome this problem, inventory turnover ratio is used.
This measure allows for better comparison among companies. This is calculated as a ratio of
company’s sales to its average inventory investment:

Inventory turnover = annual cost of goods sold/average inventory investment
This is a measure of how many times during a year the inventory turns around. It is the ratio of
the cost of annual sales to the average inventory level. The higher the inventory turns, the better
the firm uses its inventory assets. Another common measure is days of supply. A firm’s days of
supply is found by dividing the average inventory level by the cost of one day’s sales.

Example: As an example of these measures, assume a firm has an annual cost of sales of
`180 million and an average inventory level for the year of ` 20 million, then:
Inventory Turns = Cost of Sales/Average Inventory Level = ` 180/` 20 = 9 turns
The cost of sales for a day is ` 180 million/360 days = ` 0.5 million.

Because it is a relative measure, companies of different sizes can be more easily compared. A
higher turnover ratio reflects there is less idle resources in the company and therefore the
company is using its inventory more efficiently.

This ratio can only be used in this manner to compare companies that are similar. For example,
even in the same industry depending on the distribution channels, a retailer would have a much
lower inventory turnover ratio than the wholesaler or distributor.
Days of Inventory: A measure that tries to overcome the disadvantage, to a limited degree, and
is closely related to inventory turnover is ‘days of inventory’. This measure is an indication of
approximately how many days of sales can be supplied solely from inventory. The lower this
value, the more efficiently inventory is being used if customer demands are being met in full.
There are two ways of calculating ‘days of inventory’, it can be directly calculated or inventory
turnover can be converted to days of inventory. Both procedures are shown below:
Days of inventory = avg. inventory investment/annual cost of goods sold/days per year
Days of inventory = days per year/inventory turnover rate
As an example of these measures, assume a firm has an annual cost of sales of ` 18 crore and an
average inventory level for the year of ` 2 crore, then:
Inventory Turnover Ratio = annual cost of goods sold/average inventory investment
= ` 18 crore/` 2 crores = 9 turns
The cost of sales for a day is ` 18 crore /360 days = ` 5 lacs

Days of Inventory = avg. inventory investment/annual cost of goods sold/days per year
= ` 2 crore/` 5 lacs = 40 days inventory

Customer Perspective

From a customer’s perspective there are a number of ratios that are very important. The fill rates
are extremely important and reflect the responsiveness of the organization to customer needs.

The line item fill rate measures the percentage of line items on the order shipped in their
entirety.

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