What it means
The measure links the profit and loss account to the balance sheet by asking how hard the money invested in stock is working. Because stock is often the largest current asset a trading business owns, small improvements in turnover free up meaningful amounts of cash.
The standard calculation uses cost of goods sold rather than revenue, since stock is carried at cost and using sales revenue would mix in the gross margin. Some analysts still use revenue, so it is worth confirming which basis a published figure uses before comparing two companies.
Most people find the ratio easier to interpret when it is converted into days. Dividing 365 by the turnover figure gives days inventory outstanding, so a turnover of 6 becomes about 61 days of stock, which is a far more intuitive number to discuss with a buying team.
What counts as good varies enormously by sector. A supermarket may turn stock 20 or more times a year, a car dealer perhaps 6 to 8, and a jeweller or a heavy equipment distributor considerably less, so the only meaningful comparisons are against the same industry and against the company's own history.
The nuance is that a rising ratio is not automatically good news. Turnover also rises when a business has run its stock down too far and is losing sales to stockouts, or when it writes off obsolete goods, so the ratio should always be read alongside service levels and gross margin.
In practice
Real-world examples.
Example
A grocery chain reports stock turnover of 22 times because most of what it sells is perishable. Its finance team treats any fall below 20 as an early warning of ordering problems or slowing demand.
Example
A machinery distributor sees turnover fall from 5.5 to 3.8 over two years. A line by line review shows that a discontinued product range accounts for nearly a third of stock value, and the goods are written down and cleared at auction.
Example
An online retailer improves turnover from 7 to 10 by moving slow moving lines to a supplier drop shipping arrangement. The change releases roughly $400,000 of working capital, which funds an expansion of the fast moving core range.
Think of it
“Stock turnover shows how fast you sell and replace inventory-times per year you turn stock.
Formula
Calculation
Stock turnover ratio = cost of goods sold / average stock, where average stock = (opening stock + closing stock) / 2. Days inventory outstanding = 365 / stock turnover ratio
An electrical wholesaler reports cost of goods sold of $3,600,000 for the year, opening stock of $520,000 and closing stock of $680,000. Average stock = ($520,000 + $680,000) / 2 = $1,200,000 / 2 = $600,000.
Stock turnover = $3,600,000 / $600,000 = 6.0 times a year. Converting to days, 365 / 6.0 = about 61 days, so on average an item sits in the warehouse for two months before it is sold.
If the wholesaler improved turnover to 8.0 times, average stock would need to fall to $3,600,000 / 8.0 = $450,000, releasing $600,000 - $450,000 = $150,000 of cash from the balance sheet without any change in sales.Case study
Seen in the real world.
The following is an illustrative and fictional example. Halewood Trade Supplies, an invented plumbing merchant with four branches, prided itself on never turning a customer away and stocked almost every fitting a plumber might ask for. Sales were steady but the overdraft was permanently near its limit.
The fictional finance director calculated stock turnover for the first time and found 3.2 times a year, or about 114 days of stock, against an industry norm closer to 6. A branch level analysis showed that 40% of stock lines had not sold at all in twelve months, mostly obsolete or specialist fittings ordered years earlier for one off jobs.
Halewood cleared the dead lines at a $95,000 loss, moved rarely requested items to a next day supplier order, and lifted turnover to 5.4 within a year. The illustration ends with the overdraft repaid and the branches losing only a handful of sales, which was a much smaller cost than the cash that had been sitting on the shelves.
Watch out
Common mistakes.
- Using sales revenue instead of cost of goods sold in the numerator, which inflates the ratio by the gross margin and makes comparison with other companies meaningless.
- Using only the year end stock figure, which for a seasonal business is often the lowest point of the year and flatters the result.
- Assuming a higher ratio is always better, when it can also mean stockouts, lost sales or a large write off of obsolete goods.
Questions
People also ask.
What is a good stock turnover ratio?
It depends entirely on the sector, so the useful comparisons are against similar businesses and against the company's own trend rather than against a universal benchmark.
How does stock turnover affect cash flow?
Faster turnover means less cash tied up in goods on the shelf, which shortens the cash conversion cycle and reduces the need for working capital funding.
Should slow moving and fast moving lines be measured together?
Ideally not, because a blended figure hides the problem lines, and most businesses gain more from reporting turnover by category or by branch.
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