Inventory Turnover Ratio / Stock Turnover Ratio

Inventory Turnover Ratio / Stock Turnover Ratio measures how effectively stock or inventory of the company is managed. 

It is calculated by dividing the cost of goods sold with the average inventory for a particular period. The word "turnover" can be referred to as "the times something is sold". In this context, it the stock.

For Example:

Company ABC Ltd. manufactures pencils. For FY15-16, it manufactured 1200 units of pencils. The cost of manufacturing one pencil is Rs. 2. ABC Ltd had an opening balance of 200 pencils at the beginning of the financial year. At the end of FY15-16, it had a closing stock of 100 pencils. 

COGS = Rs. 2 X 1200 = Rs. 2400

Average Inventory = (200 + 100)/2 = 150 pencils

Average Inventory (in Rs) = Rs. 2 X 150 = Rs. 300

Inventory Turnover Ratio = 2400/300 = 8

It means that in the entire year the company was able to sell 8 times its average inventory.

A higher ratio indicates that a company is able to effectively sell its inventory. It is not stocking and managing its purchases properly. On the other hand, a company with a low turnover ratio indicates that the company is not able to sell. It is overstocking and not managing its purchases effectively. The ratio depends upon industry to industry.

In order to find how many days does it take for the turnover to be 1, we cross multiply

Turnover                 Days

8                              365

1                              x?

Number of days for 1 turnover (to sell 1 unit of pencil) = 365/8 = 45.625. Therefore, we can say that it takes 45.625 days for average inventory of pencils to be sold.