Formula to Calculate Stock Turnover Ratio
Stock Turnover Ratio can be defined as the frequencies with which the organization sells and then replaces its inventories during a given time. The formula for calculating Stock Turnover Ratio is represented as follows,
Where,
- The cost of goods sold equals Opening stock + Purchases Less Closing Stock.
- The cost of goods sold can be replaced by the cost of sales as well.
- Average inventory is the mean of opening stock and closing stock. In case opening stock detail is not available, we can take closing stock as well.
Explanation
It can be calculated using the below steps:
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 till the holidays in Quarter four and lower stock levels in Quarter one post those holidays.
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 the cost of 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.
Dividing COGS by average stock shall yield a stock turnover ratio.
Calculation Examples of Stock Turnover Ratio
Let’s see some simple to advanced practical examples to understand it better.
Example #1
Suppose Company C had an average inventory during the year $1,145,678, and the cost of goods sold during the same period was $10,111,987. You have required to calculate the stock turnover ratio.
Solution
Use the following data for calculation of the stock turnover ratio
- = 10,111,987 /1,145,678
- = 8.83 times
It means the stock rotates for 8 times.
Example #2
Sicco is a brand name for toothpaste in the country I. Company has taken a cash credit loan from Bank of Picco. The company is required to submit monthly stock and debtors’ details with aging on the same. Also, the company is required to submit a certain ratio, which includes the stock turnover ratio as well. The details from the company’s profit and loss statement are per below-
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Based on the above details, you are required to calculate the Inventory Turnover Ratio.
Solution
In this example, we are given a profit and loss statement, and we need to figure out the cost of goods sold and average inventory 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 of stock turnover ratio can be done as follows,
- =20329750.00/3850000.00
Stock Turnover Ratio will be –
- = 5.28 times
It means the stock rotates for 5.28 times.
Example #3
Company X is trying to evaluate 3 products that its currently selling in the market. It wants to analyze which one of the products is slow-moving and which one is the fast-moving good. On reviewing the detail of the three products, below is the summary created by the finance department.
Based on the above information, you are required to advise the management which goods are fast-moving and which is slow-moving?
Solution
In this example, we are given Average Revenue and closing stock. Since there is no opening stock information provided, 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 margin, so if we deduct the gross profit margin from revenue, we will get the cost of sales, which we shall we 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 sales margin for product 2 and 3
Cost of Sales
- =42000000.00*75.00%
- Cost of Sales = 31500000.00
Likewise, we can calculate the cost of sales for product 2 and 3
Calculation of stock turnover ratio can be done as follows,
=31500000.00/5250000.00
- = 6.00
Similarly, we can calculate the stock turnover ratio for product 2 and 3
Using this ratio, it appears that product 2 is fast-moving as it has the highest turnover ratio and product 3 is comparatively slow-moving goods, which is 5.77 verses 6 for product 1. Further, the gross profit margin of product 1 is better than product 3; henceforth, it is a wise decision to chose to shut down product 3 if at all, the company is taking such a decision.
Calculator
You can use these stock turnover ratio formula, calculator.
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Relevance and Uses
Commonly, the stock turnover ratio is used almost everywhere, whether making business decisions, or while borrowing a loan, or while valuing a firm or when comparing goods, etc. The higher the ratio, the better it is, and it means the company sells that product very quickly, and demand also exists for that product. When the turnover is low, it would mean outdated inventory or slow-moving goods. Higher turnover would also mean that the company is missing sales opportunities as it’s not carrying adequate stock.
Recommended Articles
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