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Inventory (Stock) turnover

Measures the frequency with which a business sells and replenishes inventory (stock) within a year. It can be expressed as the number of times it takes inventory (stock) to turnover in a year or the number of days (or even weeks or months) inventory (stock) is held within the business. The former is calculated by dividing cost of sales by the average inventory (stock) held in the period. The latter is calculated by dividing the average inventory (stock) held by cost of sales and multiplying by 365 to give the number of days, or 52 to give a figure for the number of weeks, or 12 to give a figure for months. NB: 1 The cost of sales figure (opening inventory + purchases – closing inventory) can be substituted with the revenue figure if the cost of sales figure is not provided / known. This is not as accurate but still useful in highlighting differences over time and / or between businesses in the same industry. 2 The average inventory figure should ideally be used, ie opening inventory at the beginning of the trading period less closing inventory at the end of the trading period divided by 2. 3 To calculate how long it takes for inventory to turnover in terms of weeks or months, the 365 would be substituted with 52 or 12 respectively. example, if the average inventory held is £5,000 and cost of sales is £120,000, then the number of times inventory turns over in a year is 24 (120,000 / 5,000). Alternatively, the amount of time it takes to sell and replenish inventory is, (rounded up), 16 days (5,000 / 120,000 x 365 = 15.21). In terms of the ‘number of times’ calculation, the higher the figure the more efficient the business. In terms of the ‘number of days / weeks / months’ calculation, the lower the figure, the more efficient the business. This means that less money is being tied up in unproductive assets and this minimises the risk of stock obsolescence (deterioration in the case of food items) and stock holding costs such as heating and lighting, security, insurance and opportunity cost (eg the loss of interest that could be gained if money held in stocks had been invested in a bank or in the business in some other way). An inventory turnover of 2 would suggest the business has about 6 months of sales in inventory, whereas an inventory turnover of 12 would mean the business only had a month’s normal sales in inventory. In most circumstances 6 months would appear to be high. When interpreting the figures, however, comparisons must be made to other firms operating within the same industry (and / or previous figures). Some businesses need high stocks and carry high values eg cars. These are slow moving items that have higher gross profit margins, which compensate for the low stock turn. Supermarkets on the other hand, would have a much higher inventory turnover as many of the items they stock need to be replaced frequently due to the short shelf life.

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