What is the Stock Turnover Ratio?
The stock turnover ratio, also known as the inventory turnover ratio, is a financial efficiency ratio that measures how often a company’s inventory is sold and replaced over a given period. In facilities management services, this metric is crucial for assessing the efficiency of inventory management. This can be excess inventory like maintenance supplies, spare parts, and other stock items necessary for the operation of facilities. A high stock turnover ratio indicates that a company is efficiently using its inventory, while a low ratio may suggest overstocking or inefficiencies in inventory management.
Benefits of Measuring and Tracking Stock Turnover Ratio (STR)
- Optimized Inventory Management: Monitoring stock turnover ratio helps maintenance teams manage inventory levels efficiently, avoiding overstocking and shortages to ensure vital parts are always available.
- Cost Efficiency: By optimizing inventory turnover ratios, teams reduce excess capital and storage costs while minimizing risks of part obsolescence or deterioration.
- Improved Maintenance Scheduling: Using inventory turnover ratio data, maintenance teams can align their schedules with stock replenishments, reducing downtime and enhancing resource use.
- Strategic Decision Making: Regular stock turnover ratio monitoring enables informed decision-making, supporting better operational and financial outcomes for maintenance operations.
How the Stock Turnover Ratio is Calculated
The stock turnover ratio, also known as the inventory turnover ratio, measures how efficiently a business manages its inventory by indicating how often the inventory is sold and replenished over a given period. This formula is universal across various industries, from retail to manufacturing to facilities management.
Formula
Stock Turnover Ratio = Cost of Goods Sold (COGS) / Average Inventory
Components Explained:
- Cost of Goods Sold (COGS): This represents the total cost of all inventory items sold by the company during the period. It includes costs related to the production or purchase of the goods sold.
- Average Inventory: This is calculated as the average inventory level held over the period, typically the average of the inventory levels at the beginning and end of the period.Average Inventory = (Inventory at the Beginning of Period + Inventory at the End of Period) / 2
Example Scenario
Consider a company with the following inventory and sales details:
- Inventory at the Start of the Year: $20,000
- Inventory at the End of the Year: $15,000
- Cost of Goods Sold during the Year: $90,000
Calculation Steps
- Calculate the Average Inventory:
- Average Inventory = (Inventory at Start of Year + Inventory at End of Year) / 2
- Average Inventory = (20,000 + 15,000) / 2 = $17,500
- Calculate Inventory Turnover Ratio:
- Inventory Turnover Ratio = COGS / Average Inventory
- Inventory Turnover Ratio = 90,000 / 17,500 ≈ 5.14
Interpretation
An inventory turnover ratio of approximately 5.14 means that the company’s inventory was effectively sold and replenished about five times throughout the year. A higher inventory turnover ratio indicates good inventory management, as the company is efficiently converting its inventory into sales. Conversely, a low turnover ratio may suggest overstocking, weak sales, inefficiencies in product movement, or possibly issues with product demand.
This metric is valuable for assessing the health of supply chain operations and the efficiency of inventory management. It aids businesses in optimizing their inventory levels to better match sales performance and market demand.
Usage
A high inventory turnover ratio indicates efficient use of inventory, suggesting that materials and supplies are being used and replenished regularly. This ideal inventory turnover ratio can be a sign of good maintenance practices and operational efficiency. A low inventory turnover ratio could indicate too much unsold inventory or inefficient inventory management, which could tie up capital unnecessarily and increase the risk of obsolete inventory.
This inventory turnover formula metric helps ensure you have the right amount of inventory on hand—enough to handle routine maintenance, emergencies, and strong sales—without holding so much inventory value that it becomes costly or inefficient.
How Stock Turnover Ratio is Used: Practical Examples
The stock inventory turnover ratio measures several practical ways within facilities management services:
- Inventory Management: This ratio helps facilities managers optimize their inventory levels, ensuring that they have the right amount of stock at the right time.
- Budgeting and Planning: Understanding inventory turnover can influence budgeting decisions and financial planning for purchasing inventory.
- Performance Analysis: A change in the stock turnover ratio can indicate a shift in sales or an issue with inventory management practices.
- Supplier Negotiations: Facilities management can use turnover ratios to negotiate better terms with suppliers or to adjust ordering practices.
For example, a facilities management company might analyze the stock turnover ratio of HVAC filters to determine if they are overstocking based on the frequency of maintenance and replacement schedules.
Ways to Reduce Stock Turnover Ratio
Reducing the stock turnover ratio might be necessary if a company finds that high turnover is leading to stockouts and potential downtime. Here are strategies to manage and potentially reduce the ratio:
- Demand Forecasting: Improving demand forecasting can help align inventory levels more closely with actual needs.
- Inventory Accuracy: Keeping accurate inventory records can prevent overordering and overstocking so that you don’t have too much inventory.
- Supplier Relationships: Developing good relationships with suppliers can lead to more flexible and responsive supply chains, allowing for smaller, more frequent orders.
- Review Ordering Processes: Regularly reviewing and adjusting ordering processes and minimum stock levels can help maintain a balanced inventory.
- Just-in-Time Inventory: Implementing a just-in-time inventory system can reduce the need to hold large amounts of stock and set up a good inventory turnover ratio.
An example of reducing the stock turnover ratio could be a facility that decides to switch to a just-in-time inventory system for cleaning supplies. By coordinating closely with suppliers and receiving goods only as they are needed for scheduled cleaning services, the facility can reduce a high turnover ratio and maintain its average inventory.
By carefully managing the stock turnover ratio, you can ensure that you have the right balance of inventory to meet operational needs without accumulating excessive capital, and you can streamline inventory management processes.