Stock turnover represents how many times a company sells through its inventory. Retail stores often use this metric to determine the efficiency of their operations. High stock turnover typically means high consumer demand exists for the company’s products. Accounting ratios provide information on calculating turnover and assessing a company’s efficient use of assets. Information from a company’s income statement and balance sheet is necessary to compute this figure and assess operations.
A company has two options for computing stock turnover. First, the formula may divide sales by inventory; second, accountants can divide cost of goods sold by average inventory. Either formula will provide the requisite information for reviewing stock turnover and determining how well the company sells through its inventory. Accountants can compute the ratios at any time during the year. Monthly and annual calculations are often the most common use of this accounting ratio.
An example is a company that has $125,000 US Dollars (USD) in sales and $85,000 USD in inventory. The stock turnover for this company is 1.47, meaning the company sells through its complete inventory nearly one and a half times each period. Assuming these formulas are for a single month, the company needs to order at least half its current inventory to meet sales. The ratio itself cannot really determine the efficient use of assets. Other steps are necessary to prove efficiency or assess operations.
Accounting ratios are common benchmark tools to assess a company’s operations. Accountants can track stock turnover for several months in a row. The benchmark process compares the current stock turnover ratio to previous periods in an attempt to discover if the company’s inventory turnover is better or worse. Companies can also use the ratio to compare their operations to an industry standard. This helps a company discover if it is operating better or worse under the same economic conditions as other businesses.
High inventory levels are often a major drawback in retail businesses. Companies typically experience increases in operating costs, which include carrying, processing, accounting, and managing activities and expenses. Companies use stock turnover ratios and review processes to determine if they can improve turnover in order to boost sales and lower costs. For example, if a company’s inventory turnover is lower than the industry average, there is potential for increasing turnover. Stock turnover that is higher than the industry average, however, may indicate a company is operating as efficiently as possible and be unable to improve turnover.