How to Calculate a Stock Turnover Ratio

To maintain a profitable business a firm must find the right inventory balance.

Stock turnover is the same as inventory turnover. To maintain a profitable business a firm must find the right inventory balance. The stock turnover ratio compares the cost of goods sold with the cost of inventory and is the best measure of efficiency in inventory management.

Instructions

1. Calculate average inventory. Take the inventory at the beginning of years one and two and divide by 2. If you have monthly balance information, add up all balances and divided by 12. For this example, $50,000 will be the opening stock and $70,000 will be the closing stock.

2. Determine the cost of goods sold. You can find this on the income statement. It is usually the second line item after revenue. In this example, the cost of goods sold is $600,000.

3. Calculate the inventory (stock) turnover ratio. The calculation equals the cost of goods sold (CGS) / average inventory. For our example, the formula is $600,000 / $60,000. The answer is 10 times.

4. Interpret the meaning of the calculation. Inventory ratios are given in terms of "times"; that is, how many "times" has the inventory "turned over." In this example, this means that $1 invested in stock or inventory is sold or replaced 10 times over the given period (one year in this example).

5. Compare against industry norms. If your ratio is low compared with industry standards, this can be a sign of inefficiencies. Likewise, a high ratio can be a sign of underinvestment.

Tips & Warnings

• If CGS is not known, an alternative ratio is "net sales" divided by "average inventory" at cost or selling price.

References

• Effective Inventory Management: Why Is Inventory Turnover Important?
• Vital Enterprises: Inventory Turnover

Resources

• Financial Education: Inventory Turnover and Days Inventory on Hand