The inventory to sales ratio looks at your investment in inventory in relation to your monthly sales amount. The inventory to sales ratio helps you identify recent increases in inventory. In contrast, the average inventory investment period may only report inventory information from the previous year, if that was the only information available to calculate the period.

The inventory to sales ratio can serve as a quick and easy way to look at recent changes in inventory levels, since it uses monthly sales and inventory information. This ratio will help predict early cash flow problems related to your business's inventory.

The inventory to sales ratio is calculated by dividing your inventory balance at the end of any month by your total sales for the same month.

Jeff's inventory balance for the previous month was $24,000, and the total sales amount for that same month was $9,600. Jeff's inventory to sales ratio is 2.5 and was calculated as:

Using the inventory to sales ratio. At first glance, the inventory to sales ratio might seem too simple to yield any useful information. But when looked at on a month-to-month basis, the inventory to sales ratio can signal potential problems in your cash flow. For example, an increase in your inventory to sales ratio from one month to the next indicates that one of the following is happening:

• your investment in inventory is growing more rapidly than sales
• sales are dropping

No matter which situation is causing the problem, an increase in the inventory to sales ratio may signal an oncoming cash flow problem.

Likewise, a decrease in the inventory to sales ratio from one month to next indicates that one of these is occurring:

• your investment in inventory is shrinking in relation to sales
• sales are increasing

Here again, no matter which situation is causing the reduction in the inventory to sales ratio, either one suggests that you are effectively managing your business's inventory levels and its cash flow.