Now that we’ve ironed out the differences between direct costs and overheads and considered your gross profit margin and your operating profit margin, let’s dive into another way we can use your financial statements to manage your small business.
In this post, we’ll look at your Stock Turnover Ratio.
This tells us the speed at which you sell your stock.
This metric only applies to product-based businesses – businesses that have stock.
We call it stock in the UK; it’s called inventory in some countries, so you may also see this as the Inventory Turnover Ratio.
How do you find your Average Stock?
Before we can calculate your Stock Turnover Ratio, we need to find your Average Stock – because you need it to calculate that. You’ll need your most recent profit & loss report and balance sheet. Let’s say you’re looking at your FY 2023-2024. On the balance sheet, look for the Closing Stock (or just Stock) figure at the end of that year. Let’s say it shows £400,000. Write that number down. Next, you need the closing stock (or stock) figure for the year before.- Your balance sheet may have the previous year’s figures to the right, usually in italics.
- Or you may need to pull your balance sheet from the year before and find the Closing Stock (or Stock) figure there.
(Closing stock + Opening stock) 2
(£600,000 + £400,000) 2
(£1,000,000) 2 = £500,000
Your Average Stock for 2023-2024 was £500,000.How do you find your Stock Turnover Ratio?
Now, let’s find your stock turnover ratio.
First, go to your profit & loss report, and find your Direct Costs total for 2023-2024. Let’s say it shows £2,500,000. Write that number down.
Now, what you need to do is:
Direct costs Average stock = Stock Turnover Ratio
£2,500,000 £500,000 = 5
That means you sold all your stock 5 times last year.
Bonus: Let’s find your Turnover Days, too
Another way to consider this is your turnover days, which is essentially flipping it around.(Average stock Direct costs) 365 = Turnover Days
(£500,000 £2,500,000) 365
(0.2) 365 = 73 = Turnover Days
This means you sold all your stock every 73 days.
73 5 = 365, so this makes sense. That is, if you sold all your stock every 73 days, and you sold it 5 times in the year, then you can multiply those two numbers together to make sure they come to 365. If they do, then you know you’ve calculated it right!
You can start with your Turnover Days and then find your Stock Turnover Ratio by flipping it around:
1 (Turnover Days 365) = Stock Turnover Ratio
1 (73 365)
1 (0.2) = 5 = Stock Turnover Ratio
Sometimes this will be easier, depending on what numbers you have to hand.
What are your Stock Turnover Ratio and Turnover Days?
Now, go grab your most recent financial statements and calculate your figures. I’ll wait. 😊
What do these tell us?
Your Stock Turnover Ratio tells us:- How fast your stock sells
- How effectively it meets market demand
- How its sales compare to other products in its category
- Goods are sold faster
- You have reduced holding costs
- There are weak sales of your products, and/or
- You have more inventory than you need
You can calculate this as often as you know how much stock you have on hand. That might be from a monthly, quarterly, or annual stock take, or (hopefully) you can pull your current stock figure at any time from your inventory management system.
How can you use your Stock Turnover Ratio?
You can use it to compare your various products, product lines, or arms of your business, if you have the Direct Costs separated that way in your management accounts.
This is probably the most useful way to use it in managing your small business. It can help you decide
- Which products to keep selling and which to let go
- Which products to stock more or less of in different months or quarters
- How much warehouse space you’ll need
You can also compare it to:
- Your own planned ratios – to help keep you on track as the weeks and months progress
- Industry averages – to help you see what’s possible in your industry
- Competitors’ ratios – but read below for caveats
What should you know when comparing Stock Turnover Ratios?
As always, consistency is key.If you change what’s going into your direct costs, then your historical comparisons won’t be clear.
If you sell both products and services, you may have direct costs for both. For example,
- You will usually put payment processing fees for your service clients’ payments, and
- You may put software necessary to provide your services
Because this is based on figures you can obtain from Companies House filings, at least for businesses over a certain size presently (and more companies soon), you can use this to compare against your competitors.
Be aware, though, that you don’t know what’s gone into their Direct Costs figure – they may include things you don’t, or exclude things you include – so while it can give you a ballpark idea, don’t think you can compare these figures with great precision.
Conclusion
The Stock Turnover Ratio is another tool in your management arsenal.- Use it to help you see which products and product lines are selling better and worse.
- Use it to help you work out whether you should get a bigger warehouse, or simply rent more storage space during Q4.
- Use it to set targets that help you reduce your warehousing costs.
- Use it to see the sales impact of changing prices.
- Use it to see how your business compares to the rest of your industry.
Hi, I’m Sara-Jayne Slocombe of Amethyst Raccoon. I help your small business thrive using the power of your numbers, empowering you so that you have the confidence and knowledge to run your business profitably and achieve the goals you’re after.
I am a UK-based Business Insights Consultant, which means I look at your data and turn it into information and insights. I separate the noise from the signal and translate it all into actions that you can actually take in your business.
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