Stock Turnover ratio
The inventory turnover ratio is a measure of efficiency that contrasts average inventory over time with cost of goods sold to demonstrate how well inventory is handled. This gauges how often an average amount of merchandise is “churned” or sold over time. In other words, it counts the number of times a corporation sold its annual average dollar amount of inventory. With an average inventory of $1,000 and sales of $10,000, a business successfully sold its inventory ten times over.
Because overall turnover relies on two key performance factors, this ratio is significant. The first element is stock acquisition. In order to increase turnover, the firm will need to sell more inventory if it makes higher year-over-year purchases. If the business is unable to sell these larger quantities of goods, it will have to pay for storage and other holding expenses.
The sales element is the second. Sales must equal inventory purchases in order for the inventory to churn efficiently. Because of this, coordination between the buying and sales teams is essential.
Formula
The inventory turnover ratio is calculated by dividing the cost of goods sold for a period by the average inventory for that period.
Stock (Inventory) Turnover ratio = Cost of Goods Sold / Average inventory
Analysis
Inventory turnover is a measure of how efficiently a company can control its merchandise, so it is important to have a high turn. This shows the company does not overspend by buying too much inventory and wastes resources by storing non-salable inventory. It also shows that the company can effectively sell the inventory it buys.
This measurement also shows investors how liquid a company’s inventory is. Think about it. Inventory is one of the biggest assets a retailer reports on its balance sheet. If this inventory can’t be sold, it is worthless to the company. This measurement shows how easily a company can turn its inventory into cash.
