4.26 : Activity Ratios: Stock Turnover Ratio

The stock turnover ratio, or the inventory turnover ratio, is a crucial metric for assessing how efficiently a company manages its inventory. It reflects how frequently a company's inventory is sold and restocked within a given period, typically a year. This ratio is critical for businesses to understand how well stock levels are managed to optimize the use of capital invested in inventory.

The stock turnover ratio is calculated by dividing the cost of goods sold (COGS) by the average book value inventory over a given period. The average inventory is computed by adding the opening book value of inventory to the closing book value inventory and dividing the sum by two.

A higher stock turnover ratio implies that a company effectively manages its inventory, quickly selling goods and replenishing stock as needed. This minimizes the risk of overstocking, which can tie up capital and increase storage costs.

Conversely, a lower ratio suggests inefficiency in inventory management, potentially leading to excess stock and reduced liquidity. Maintaining an optimal stock turnover ratio balances product availability with operational efficiency.