Stock turnover ratio

 Meaning: this ratio establishes a relation ship between costs of goods sold and average inventory.

Objective: the objective of component of this ratio is to determine the efficiency with which the inventory is utilized.

Components: there are two components of this ratio which are as under:

Cost of goods sold

Average inventory

Computation: this ratio is computed by dividing the cost of goods sold and average inventory. This ratio is usually expressed as x number of times. In the form of a formula this ratio may be expressed as under:

Stock turnover ratio = cost of goods sold/ average inventory

Cost of goods sold = sales - gross profit

Note:

If opening stock is not known closing stock can be taken.

If there is any complexity in calculating cost of goods sold then.

 Interpretation: It shows the speed with which the inventory is converted into sales. In general a high ratio indicates efficient performance since an improvement in the ratio shows that either the same volume of sales has been maintained with a lower investment in stock or the volume of sales has increased without any increase in the amount of stocks. However too high ratio and too low ratio call for further investigation. A too high ratio may be the result of a very low inventory levels which, ay result in frequent stock outs and thus the firm may incur high stock out costs. On the other hand a too low ratio may be the result of excessive inventory level slow moving or obsolete inventory and thus the firm incurs high carrying costs. Therefore a firm should have neither a very high not a very low stock turnover ratio it should have a adequate level.