What is Stock Turnover Ratio?

Stock Turnover Ratio Formula

Stock Turnover Ratio Formula = Cost of Goods Sold /Average Inventory

Where,

  • The cost of goods soldCost Of Goods SoldThe Cost of Goods Sold (COGS) is the cumulative total of direct costs incurred for the goods or services sold, including direct expenses like raw material, direct labour cost and other direct costs. However, it excludes all the indirect expenses incurred by the company.
  • read more equals Opening stock + Purchases Less Closing Stock.The cost of sales can replace the cost of goods sold.Average inventory is the mean of opening stock and closing stockClosing StockClosing stock or inventory is the amount that a company still has on its hand at the end of a financial period. It may include products getting processed or are produced but not sold. Raw materials, work in progress, and final goods are all included on a broad level.read more. If opening stock detail is not available, we can take closing stock as well.

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Steps to Calculate Stock Turnover Ratio

Examples

Let’s see some simple to advanced practical examples to understand it better.

  • For a company, the cost of goods sold (i.e., COGS) is a yardstick for the production costs of services and goods. The cost of goods sold shall include labor costs, which are directly related to stock produced, materials, and any other fixed costs or factory overhead, which are directly used for producing those goods. The average stock needs to be computed as firms might carry lower or higher stock levels at a certain period during the year. E.g., Retailers such as Best Buy Co. Inc. might carry higher stock, which leads to the holidays in Quarter four and lower stock levels in Quarter one post those holidays. Dividing COGS by average stock will calculate the stock turnover ratio.

Example #1

Suppose Company C had an average inventory of $1,145,678, and the cost of goods sold during the same period was $10,111,987. You are required to calculate the stock turnover ratio.

Solution

Use the following data –

  • Cost of Goods Sold: 10111987.00Average Inventory: 1145678.00

  • =  10,111,987 /1,145,678

  • = 8.83 times

It means the stock rotates eight times.

Example #2

Cisco is a brand name for toothpaste in country I. The company has taken a cash credit loan from the Bank of Picco. The company must submit monthly stock and debtors’ details with aging on the same. Also, the company is required to submit a certain ratio, including the stock turnover ratio. The details from the company’s profit and loss statement are per below-

Based on the above details, you must calculate the Inventory Turnover Ratio.

In this example, we are given a profit and loss statement, and we need to figure out the cost of goods sold and average inventoryAverage InventoryAverage Inventory is the mean of opening and closing inventory of a particular period. It helps the management to understand the inventory that a business needs to hold during its daily course of business.read more as well.

Calculation of  Cost of Goods Sold

Cost of Goods Sold=Opening Stock + Net Purchases – Closing Stock

= 3,500,000 + ( 21,350,000 – 320,250 ) – 4,200,000

  • Cost of Goods Sold = 20,329,750

Calculation of Average Stock

Average Stock = ( Opening Stock + Closing Stock ) / 2

=  ( 3,500,000 + 4,200,000 ) / 2

  • Average Stock  = 3,850,000

Calculation can be done as follows,

  • =20329750.00/3850000.00

Stock Turnover Ratio will be –

  • = 5.28 times

It means the stock rotates 5.28 times.

Example #3

Company X is trying to evaluate three products currently selling in the market. It wants to analyze which one of the products is slow-moving and which one is the fast-moving goods. On reviewing the details of the three products, below is the summary created by the finance department.

Based on the above information, you must advise the management which goods are fast-moving and slow-moving?

In this example, we are given Average Revenue and closing stock. Since there is no opening stockOpening StockOpening Stock is the initial quantity of goods held by an organization during the start of any financial year or accounting period. It is equal to the previous accounting period’s closing stock, valued in accordance with appropriate accounting standards based on the nature of the business.read more information, we can take closing stock as a proxy for our computation purposes. Further, we are also not given purchases, and hence we cannot calculate the cost of goods sold with that formula. Still, instead, we are given a Gross profit marginGross Profit MarginGross Profit Margin is the ratio that calculates the profitability of the company after deducting the direct cost of goods sold from the revenue and is expressed as a percentage of sales. It doesn’t include any other expenses into account except the cost of goods sold.read more, so if we deduct the gross profit margin from revenue, we will get the cost of sales, which we shall use in the below formula.

Stock Turnover Ratio formula = Cost of goods sold or cost of sales /Average Inventory or Closing stock

Cost of Sales Margin For Product 1

=1-25.00%

  • Cost of Sales Margin = 75.00%

Similarly, we can calculate the cost of salesCost Of SalesThe costs directly attributable to the production of the goods that are sold in the firm or organization are referred to as the cost of sales.read more margin for products 2 and 3

Cost of Sales

  • =42000000.00*75.00%Cost of Sales = 31500000.00

Likewise, we can calculate the cost of sales for products 2 and 3

The calculation can be done as follows,

=31500000.00/5250000.00

  • = 6.00

Similarly, we can calculate the stock turnover ratio for products 2 and 3

Using this ratio, product 2 is fast-moving as it has the highest turnover ratio and product 3 is comparatively slow-moving goods, which is 5.77 versus 6 for product 1. Further, the gross profit margin of product 1 is better than product 3; subsequently, it is wise to choose to shut down product 3 if the company is taking such a decision.

Walmart Stock Turnover Ratio

What is the inventory turnover for the company? Walmart, the US retailer giant, is an example of the best inventory management system. Below is theStatement of Financial Position represents the current financial status of an entity in terms of assets and liabilities. This statement is used by the stakeholders and shareholders as it affects their investing decisions.read more Statement of financial positionStatement Of Financial PositionStatement of Financial Position represents the current financial status of an entity in terms of assets and liabilities. This statement is used by the stakeholders and shareholders as it affects their investing decisions.read more and Income statementIncome StatementThe income statement is one of the company’s financial reports that summarizes all of the company’s revenues and expenses over time in order to determine the company’s profit or loss and measure its business activity over time based on user requirements.read more for Walmart.

Source: WalMart Annual Report

The cost of goods sold can be found in the income statement above. And the average inventory can be calculated by taking the year-end inventories for FY 2019 and FY 2018.

Hence, Average inventory = Average of $44,269 and $43,783 = $44,026

Dividing Cost of goods sold by the average inventory,

We get a stock turnover of 8.75.

Inference: Walmart turned over its inventory 8.75 times in FY2019 to generate sales corresponding to the cost of goods sold, equating to $385,301. A high turnover ratio is desirable for Walmart because of its retail business, where observed high inventoryTurnover Ratios are the efficiency ratios that measure how a business optimally utilizes its assets to generate sales from them. You can determine its formula as per the Turnover type, i.e., Inventory Turnover, Receivables Turnover, Capital Employed Turnover, Working Capital Turnover, Asset Turnover, & Accounts Payable Turnover. read more turnover ratiosTurnover RatiosTurnover Ratios are the efficiency ratios that measure how a business optimally utilizes its assets to generate sales from them. You can determine its formula as per the Turnover type, i.e., Inventory Turnover, Receivables Turnover, Capital Employed Turnover, Working Capital Turnover, Asset Turnover, & Accounts Payable Turnover. read more.

How to Interpret Stock Turnover Ratio?

  • The higher the stock turnover ratio, the better it is, and it means the company sells that product very quickly, and demand also exists for that product. A higher ratio may also mean that the company is missing sales opportunities as it’s not carrying adequate stock. It might also mean that the company is frequently purchasing. It can also put the business in difficulty if prices from the suppliers’ end rise.When the stock turnover is low, it would mean outdated inventory or slow-moving goods. It can be a signal toward inefficient working capital management. Nevertheless, it can be a strategy of stock building done knowingly.

Limitations

Stock turnover ratio is a critical measure for a company and is widely used in financial analysisFinancial AnalysisFinancial analysis is an analysis of finance-related projects/activities, company’s financial statements (balance sheet, income statement, and notes to accounts) or financial ratios to evaluate the company’s results, performance, and trends, which is useful for making significant decisions such as investment, project planning and financing activities.read more; however, it has certain limitations;

  • Stock turnover can not be relied upon completely to draw comparisons among peers without regard to certain similarities. A manufacturing business can find its inventory turning over slower than a restaurant business.A high turnover, which is, on the one hand, good for analysts, can have a discerning side when the firm sees more cash tied-up in the system than a low turnover operation.

This article has been a guide to Stock Turnover Ratio and its meaning. Here we discuss how to calculate the stock turnover ratio and examples and interpretations. You can learn more about financial analysis from the following articles –

  • Turnover Ratios FormulaTurnover Ratios FormulaTurnover Ratios are the efficiency ratios that measure how a business optimally utilizes its assets to generate sales from them. You can determine its formula as per the Turnover type, i.e., Inventory Turnover, Receivables Turnover, Capital Employed Turnover, Working Capital Turnover, Asset Turnover, & Accounts Payable Turnover. read moreExamples of Profit and Loss Statement Activity RatiosInventory Turnover Ratio CalculationInventory Turnover Ratio CalculationInventory Turnover Ratio measures how fast the company replaces a current batch of inventories and transforms them into sales. Higher ratio indicates that the company’s product is in high demand and sells quickly, resulting in lower inventory management costs and more earnings.read more