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Stock Turnover Ratio

The speed with which a business converts inventory into sales is an important indicator of business activity. The management of any business enterprise must maintain adequate quantity of stock on hand (or inventory) in order to continue the business as a going concern. But it must avoid an accumulation of inventory in excess of normal requirements for the simple reason that the excessive stocks not only tie up the funds ad increase storage costs but they may also lead to subsequent losses if the goods become outdated or unshakeable. Inventory turnover ratio can be compute don the cost basis or sale basis by applying one of these equations:

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


Stock Turnover Ratio = Net Sales/Average Inventory at Selling price

It is, thus clear that this ratio establishes relationship between average inventory at cost and cost fo goods sold or between average inventory at sale price and the net sales. In short, this ratio relates the number f times the stock is turned over on the average and must be replaced during a given accounting period. Other names for this ratio are : Stock Velocity Ratio or Inventory Turnover Ratio or Merchandise Inventory Turnover.

Components: Of the two methods fo calculating stock turnover ratio, the best is one which uses the cost goods sold and the average inventory at cost. The reason for using cost of goods sold in the calculation is that the inventory figure in the denominator is at cost. It is, therefore, reasonable to use cost figure in the numerator. But in many cases, the cost of goods sold figure may not be available. The details provided may be limited to sales and a lump sum figure representing the sum of the cost of goods sold and operating expenses. In the absence of a better method, the ratio is them computed as sales to inventor at cost price as given below:

Net Sales/Average Inventor at Cost

The next point is in respect of average inventory. We have to use the average figure of the year because the amount of inventor is generally fluctuating from month to month. The best way of computing average through January and divide by 13. However, this information is not available, and there, average inviter is sally computed by adding beginning inventor to ending inventory and dividing by 2, as shown below:

Average Inventory = Beginning Inventory + Ending Inventory / 2 If it is not possible to calculate average inventory figure, inventory at illustration 10 )Stock Turnover Ratio)

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