Activity Ratios: Stock Turnover Ratio

The stock turnover ratio, also known as inventory turnover ratio, measures how efficiently a company manages its inventory.

For calculating the stock turnover ratio, the cost of goods sold is divided by the average Inventory.

A higher ratio suggests efficient inventory management, implying that the company sells goods quickly, while a lower ratio may indicate overstocking.

Consider Freshly, a retail company with a cost of goods sold of five hundred thousand dollars for the year.

At the beginning of the year, inventory was eighty thousand dollars, while at the end, it was one hundred twenty thousand dollars.

The average inventory is calculated by adding the beginning and ending inventory and dividing the sum by two, which amounts to one hundred thousand dollars.

Here, the stock turnover ratio for Freshly will be calculated as five.

This means that Freshly sold and replaced its inventory five times during the year by managing its inventory efficiently and turning it into sales.

Businesses aim for a balance in stock that maximizes sales without overstocking, which ties up capital.