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Step 1
Calculate average inventory. Take the beginning and end of period inventory and divide by 2; that is, 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, let's use $50,000 as the opening stock and $70,000 as the closing stock.
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Step 2
Determine the cost of goods sold. You can find this on the income statement. It is usually the second line item after revenue. Let's say the cost of goods sold is $600,000.
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Step 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.
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Step 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." For our 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).
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Step 5
Compare against industry norms. It is one thing to track the inventory ratio for your company, but looking at it in comparison with other ratios in the same industry can provide a great deal of insight on opportunities to improve operations. If your ratio is lower compared to industry standards it can be a sign of inefficiencies. Likewise, a high ratio can be a sign of underinvestment.
