Stock Turnover RatioDefined along with Formula & How to Calculate

Written By:
Lisa Borga

What is the Stock Turnover Ratio?

The stock turnover ratio, also known as the inventory turnover ratio, measures the number of times a business’s inventory is bought and sold during a given period of time.

The inventory turnover ratio is calculated by dividing the cost of goods sold (COGS) by the average inventory value.

This ratio is useful for management because it lets them know how quickly their inventory is being turned into sales.

This can allow management to determine their optimal inventory level.

Stock Turnover Ratio Formula

Stock Turnover Ratio Formula = Cost Of Goods Sold / Average Value Of Inventory

Where:

Cost Of Goods Sold = Beginning Inventory + Net Purchases – Ending Inventory

The cost of sales can be used in this formula instead of the COGS.

And:

Average Inventory = (Beginning Inventory + Ending Inventory) / 2

How to Calculate the Inventory Turnover Ratio

Here are the steps for computing the inventory turnover ratio.

First, it is necessary to calculate the cost of goods sold.

The COGS includes any direct costs that are involved in making a product, such as labor, materials, factory overhead, as well as other fixed costs.

Next, the average inventory must be determined.

This is important since the amount of inventory can vary considerably throughout the year.

Many stores will carry a larger amount of inventory around the holidays than throughout the rest of the year.

Once the COGS and the average inventory are calculated, the inventory turnover ratio can be computed by dividing the COGS by the average inventory value.

Next, we will give you some examples to help you see how this ratio is calculated.

Example 1

We will use company A as an example.

Company A had a COGS of $25,000,000 for the year and an average inventory of $2,700,000 for the same period.

We will now calculate the inventory turnover ratio.

Cost of Goods Sold: $25,000,000

Average Inventory Value: $2,700,000

Stock Turnover Ratio = Cost Of Goods Sold / Average Value Of Inventory

Stock Turnover Ratio = $25,000,000 / $2,700,000

Stock Turnover Ratio = 9.26

This inventory turnover ratio indicates that the inventory turned over 9.26 times during the year.

Example 2

Company B makes piggy banks for children.

This company took out a loan from a bank.

The bank requires the business to submit information about its stock and debtors, including aging every month.

The business is also required to provide the bank with its inventory turnover ratio.

We will calculate the inventory turnover ratio.

This income statement can be used to determine the inventory turnover ratio.

The income statement shows the COGS, which we will need for determining the stock turnover ratio.

If we had not had the COGS already calculated for us, we would have added the beginning inventory and the net purchases and then subtracted the ending inventory.

In this case, the COGS is $105,000.

Cost Of Goods Sold = Beginning Inventory + Net Purchases – Ending Inventory

We will also need the average inventory value.

This can be obtained by adding the beginning and ending inventory and dividing it by two.

Average Inventory = (Beginning Inventory + Ending Inventory) / 2

Average Inventory = (35,000 + 37,000) / 2

Average Inventory = 36,000

Now that we have the COGS and the average inventory value, we can calculate the inventory turnover ratio.

We do this by dividing the cost of goods sold by the average inventory value.

Stock Turnover Ratio Formula = Cost Of Goods Sold / Average Value Of Inventory

Stock Turnover Ratio Formula = $105,000 / $36,000

Stock Turnover Ratio  = 2.92

This indicates the stock turned over 2.92 times during the year.

Example 3

Company C is analyzing three of its products.

The company wants to determine which of its products is selling the fastest and which is selling the slowest.

Here is some data the company obtained about these three products.

We will use this data to determine which product is selling the fastest and which is selling the slowest.

For the following example, we have ending inventory and average revenue.

However, we do not have beginning inventory.

But, we can use ending inventory instead.

We also do not have COGS, but we have the gross product margin, which we can use.

We can use the gross profit margin to obtain the cost of sales and then use the figure in the following formula.

Stock Turnover Ratio formula =  cost of sales or cost of goods sold /ending inventory or average inventory value

This will allow us to compute the inventory turnover ratio for all three products.

Product 1

Cost of Sales Margin = 1 – 26% = 74%

Cost of Sales = 630,000 x 74% = 466,200

Stock Turnover Ratio = 466,200 / 75,600

Stock Turnover Ratio = 6.17

Product 2

Cost of Sales Margin = 1 – 21% = 79%

Cost of Sales = 750,000 x 79% = 592,500

Stock Turnover Ratio = 592,500 / 67,500

Stock Turnover Ratio = 8.78

Product 3

Cost of Sales Margin = 1 – 23% = 77%

Cost of Sales = 790,000 x 77% = 608,300

Stock Turnover Ratio = 608,300 / 110,600

Stock Turnover Ratio = 5.50

After calculating the inventory turnover ratio for each of these products, the business can see that product 2 is selling the fastest because the product has an inventory turnover ratio of 8.78, which is the highest of the three products.

In contrast, product 3 moves the slowest.

Product three has an inventory turnover ratio of 5.50.

Product three does have a slightly higher profit margin at 23% versus 21% for product 2.

However, the company might want to consider whether or not it wants to continue selling product 3.

Best Buy Inventory Turnover Ratio

Best Buy is a large consumer electronics retailer.

As a real-life example, we are going to calculate the stock turnover ratio for Best Buy.

The COGS of 36.75 billion can be obtained from Best Buy’s income statement.

Best Buy’s inventory for 2021 was $5.612 billion.

These figures can be used to determine Best Buy’s stock turnover ratio.

Inventory Turnover Ratio = Cost Of Goods Sold / Average Value Of Inventory

Inventory Turnover Ratio = 36,750,000,000 / 5,612,000,000

Inventory Turnover Ratio = 6.55

This gives Best Buy an inventory turnover ratio of 6.55.

Interpreting the Inventory Turnover Ratio

Companies generally prefer to have a high inventory turnover ratio.

This is preferable because it means that the company is selling its goods quickly.

It also means that there is a good deal of consumer demand for their products.

However, this level of sales does require a company to purchase goods frequently.

This can cause some problems if prices rise quickly.

Additionally, if the ratio is particularly high, it could indicate that the business is missing out on sales by not having an adequate inventory.

If a company has a low stock turnover ratio, this indicates that its goods are not selling very quickly or it has an outdated inventory.

This could mean that the business does not effectively manage its working capital.

Although, the business may be trying to build up stock as a part of its strategy, thereby causing a low stock turnover ratio.

Limits of the Stock Turnover Ratio

These stock turnover ratios are extremely important for businesses as well as for financial analysis.

However, the ratio does have its limitations.

This ratio is often not useful in comparing companies between different industries.

This is due to the fact that a good inventory turnover ratio can vary according to the industry.

A high stock turnover ratio also does not show which products are moving quickly or slowly.

This requires more analysis.

Additionally, companies can manipulate the stock turnover ratio, such as by using only the ending inventory of the business, which may not give a good picture of what is going on in the business.