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Definition: Stock Turnover Ratio
All firms maintain an inventory of the goods produced. Stock turnover ratio gives the relationship between the inventory of a company and cost of goods sold over a particular period of time. Stock turnover ratio can be defined as:
Stock turnover ratio = Cost of Goods Sold/Average inventory
If Cost of Goods sold is not directly available from financial statements, stock turnover can be computed as follows:
Stock turnover ratio = Net Sales/Average inventory
Average inventory is calculated as (beginning inventory ending inventory)/2.
This ratio is expressed in number of times, it refers to the number of times the inventory has been sold and replaced with new inventory. Stock turnover ratio is an indicator of efficiency of the company – higher the number of stock turns; it indicates efficient management of inventory. High stock turnover ratio may also sometimes imply a risk of stock shortage. A low inventory turnover ratio implies – low sales, accumulation of obsolete inventory in warehouse, low quality of product and low profitability.
Companies which sell items which have low shelf-life have high stock turnover ratio, hence this ratio should be used only to compare performances of companies within the same sector. It is also important to remember that this ratio does not hold for companies which belong to the service sector.