Stock Turnover Ratio Analysis
The phrase "stock turnover ratio" may not ring a bell for people with no background in inventory management. But for corporate logistics managers, this ratio represents an important tool to evaluate a company's operating performance. Stock turnover ratio is also a cardinal indicator that investors keep a close eye on, especially for companies holding substantial inventory amounts.
Other People Are Reading
-
Definition
-
Stock turnover ratio is a numerical indicator that tells the tale of how a company manages its inventories. The ratio equals average inventories divided by daily costs of goods sold. Daily costs of materials equal total costs of materials divided by 365. An important index in inventory appraisal, stock turnover ratio indicates how adeptly a firm sells its inventories. Organizations rely on state-of-the-art technological tools and equipment to assess inventory turnovers, especially in industries requiring a large volume of materials shipments and receipts. These tools include customer relationship management applications, enterprise resource planning software and supply chain administration programs.
Significance
-
Accurately evaluating a company's stock turnover ratio is an important exercise. Beyond the operational implications of the ratio, top leadership relies on inventory data to gauge a firm's financial soundness. Specifically, management keeps a close eye on how stock turnover ratio impacts other important indicators, such as working capital and profit margin. Working capital measures how much cash a firm has in the short term and equals current assets minus current debts. Profit margin provides insight into a firm's revenues-and-expenses levels and equals net income divided by total sales.
-
Financial Reporting
-
Corporate accounting personnel generally analyze stock turnover ratios as part of financial reporting processes and methodologies. These processes enable firms to assess how inventory, a short-term asset account, affects other financial accounts. Accountants record inventories in the balance sheet, otherwise known as a statement of financial condition or statement of financial position. In addition to the balance sheet, financial analysts and investors pay close attention to corporate statements of income, cash flow reports and statements of equity. "Statement of income," "profit and loss statement" and "income report" are identical terms.
Illustration
-
The management of a large, international gardening-equipment maker is concerned that South American operations are falling behind the competition. Top executives at the U.S. corporate headquarters want to review inventory management procedures at local warehouses. The corporate controller notes that daily costs of materials for the years 2008, 2009 and 2010 average $5,000, $4,000 and $5,000, respectively. Average stocks for 2008, 2009 and 2010 equal $50,000, $75,000 and $150,000. The controller calculates stock turnover ratios for all three years. The ratios for 2008, 2009 and 2010 equal 10 ($50,000 divided by $5,000), 18.75 ($75,000 divided by $4,000) and 30 ($150,000 divided by $5,000), respectively. The results indicate to the controller that it took 10 days to sell incoming inventories in 2008. However, the number of days increases to 18.75 and 30 in 2009 and 2010, respectively. This means that the company's South American subsidiaries are holding inventories longer than in previous years -- a sign of weak sales.
-
