However, the context must also be closely considered, such as confirming that the time from customer order to delivery is on par or above that of industry comparables.įor instance, ordering less inventory might improve the turnover ratio, yet doing so is at the cost of missing out on potential revenue and the heightened risk of falling behind competitors with regard to order fulfillment and customer satisfaction. If the company’s inventory remains unsold, management might eventually decide to write down some of its inventory value to better reflect the fair value on the balance sheet (or all of the value could be wiped in a write-off). The build-up of excess inventory tends to be perceived negatively, as it often stems from overstocking and a poor understanding of customer spending behavior. Low Stock Turnover Ratio → Weak Customer Demand in Market + Excess Inventory.High Stock Turnover Ratio → Strong Customer Demand in Market + Efficiency Inventory Management.Given that the stock turnover ratio tracks the number of times that a company’s inventory balance is cleared out and needs to be replaced over a specified period, companies typically aim to raise their turnover ratio. Stock Turnover, 2022A = $100 million ÷ $40 million = 2.5xĪ high ratio of inventory turnover and the need to order more frequently goes hand-in-hand with strong customer demand and efficient inventory management (i.e.Stock Turnover, 2021A = $95 million ÷ $50 million = 1.9x.Stock Turnover, 2020A = $90 million ÷ $60 million = 1.5x.In closing, the stock turnover ratio of our hypothetical company was 1.5x, 1.9x, and 2.5x from 2020 to 2022. Since the cost of goods sold (COGS) was provided, the next step is to divide the COGS incurred each period by the average inventory balance. Our first step is to determine the average inventory balance for each period.
Suppose we’re tasked with calculating the stock turnover ratio for a consumer retail company using the following financial assumptions. The formula to calculate the stock turnover ratio is as follows.
Calculate Average Inventory (Beginning and End of Period Balance).The steps to calculate the stock turnover ratio are as follows: in a year-over-year analysis) – as well as to that of its industry peer group – which are both practical methods to derive insights into the management team’s inventory management decisions and future business trajectory. The stock turnover ratio of a company can be compared relative to historical trends (i.e. Since the stock turnover ratio counts the number of times that a company needed to replenish its inventory, a higher ratio implies that the company is converting inventory purchases into revenue more efficiently (and vice versa for a lower turnover ratio). The term “stock” refers to the inventory owned by a company and is recorded as a current asset on the balance sheet, as the company expects to cycle through this inventory within the next twelve months. The stock turnover ratio is a method to measure a company’s operating efficiency at converting its inventory purchases into customer sales. Stock Turnover Ratio Calculation Example.