How do you calculate a stock turnover rate?

A company's performance and competitiveness are directly linked to its ability to manage its stocks.

Managing them well is therefore essential, especially since it helps reduce the costs associated with overstocking.

Efficient stock management requires, first of all, high product turnover.

In this article we explain everything you need to know about stock and how to properly calculate your turnover ratio.

What is stock turnover?

Stock turnover ratio: definition

Stock turnover designates the frequency with which a company renews its goods over a given period of time.

Calculating your turnover ratio is essential, as it's an accurate indicator of supply chain efficiency.

Rapid turnover means good management: products never stay in the distribution centre too long.

Calculating a company’s turnover ratio thus allows us to determine its performance in terms of how it manages its purchases, stocks and supplies.

This ratio also tells us whether forecast stock requirements are accurate. Many companies use forecasting to limit their stocks of goods and thereby avoid overstocking and idle stocks.

If a stockout occurs, the turnover ratio falls and this indicates that the company has underestimated its stock requirements: which means its buffer stock is insufficient.

Therefore the objective is not to keep the turnover ratio as high as possible, but rather to keep it consistent with the real needs of the company.

Turnover is directly linked to competitiveness, which means it’s an essential indicator to follow.

Optimized stock turnover - what’s at stake

The faster the turnover of stock, the better the company is performing. It’s therefore important to calculate the turnover ratio to make sure it’s acceptable or to optimize it as appropriate.

Optimized stock turnover has many benefits:

1. Improved stock management

No overstocking and no dormant stock, which alsohelps avoid unnecessary costs. Poor stock management entails various expenses, such as storage and maintenance.

Depending on the nature of the goods, there’s also the risk of obsolescence or expiry.

Poor stock management can result in the destruction of goods that have not been moved in time, with a direct financial loss as a consequence.

2. Improved stock management means improved cash flow

Overstocking immobilizes capital unnecessarily and affects working capital requirements.

3. The company avoids stock shortages

And all the related inconveniences, like disgruntled customers. Stock shortages can cause the whole supply chain to slow down or even stop working completely.

However, there are limits to the usefulness of the stock turnover ratio:

• For starters, it’s just an average. Therefore it may not be representative at a given instant, for example if there are significant fluctuations in stocks of seasonal products. It indicates a general trend over a given period, but is not an absolute indicator. The turnover ratio therefore has to be considered in context.
• Similarly, there are differences depending on industry and stock type. A food retailer’s supply chain will necessarily have a very high turnover ratio, since it handles perishable products which must therefore be shifted quickly.

To a lesser extent, the same applies to clothing by “fast-fashion” brands, where collections are constantly renewed, sometimes from one week to the next. 

Conversely, a supply chain managing products that take time to manufacture, and that are in lasting demand with customers, will necessarily have a lower turnover ratio - not a symptom of potential gaps in the supply chain in this case.

The real significance of a company’s stock turnover ratio lies in how it compares to the ratios of other players in the same sector.

How can stock turnover be improved?

Efficient stock rotation has many advantages. Here are several ways to improve it:

Optimize restocking of your warehouse

You need to choose suppliers who can deliver faster or negotiate shorter lead times. This could lead you to choose suppliers who are geographically close to you, especially if restocking involves frequent deliveries.

The role of suppliers in the supply chain is decisive, so you need to find the best compromise between prices charged and the service rendered (lead times, responsiveness when needed etc.).

Improve OTD

Your OTD rate expresses your ability to minimize stock disruptions during restocking cycles. In other words: avoid losing sales due to unavailability of stock at time T.

With the exception of specific products that cannot be obtained elsewhere, customers do not wait for restocking.

If you can't satisfy them immediately or if you impose too long a delivery time, they will buy from a competitor who will be able to process their order immediately.

Achieving 100% OTD is almost impossible, but that’s the goal you have to strive for.

Anticipating workflows

To improve your stock turnover ratio, you need to forecast requirements as accurately as possible. That way you can adjust stock levels to the expected volume of demand, keeping stock levels low without risking stockout.

How to calculate stock turnover

As we saw, the “correct” frequency of stock turnover varies from one enterprise to another, depending on its sector of activity and the products it manages (seasonality, expiry, obsolescence etc.).

It may also be longer or shorter depending on the length of the operating cycle. A long cycle means low turnover, while a short cycle requires high turnover.

To calculate your turnover ratio, divide the stock of goods by the purchase price of the goods sold. Then multiply the result by the number of days in the period. Generally, this period is one year, so we multiply by 365 (for 365 days). This gives the annual turnover ratio.

Important: when you calculate your average stocks, you must also consider restocking made over the calculation reference period.

The “initial stock minus final stock” formula does not take this factor into account, and may mislead.

Stock management: objectives and indicators

Stock turnover is a useful indicator of supply chain efficiency:

• Low turnover may indicate overstocking or dormant stock. Stock only has value if it's actually sold. Low turnover impacts cash flow, as its hampers liquidity. By improving stock control, you protect the value of your stock.
• High turnover is positive, as it indicates that the supply chain is working well and goods are not stagnating in the distribution centre. However, too high a turnover may also indicate that buffer stocks are insufficient, which could lead to stockout if demand suddenly increases.

How to calculate the stockout ratio?

To manage your supply chain as well as possible, you need to consider different indicators. And if you need to know the stock turnover ratio, you also need to consider the stockout ratio.

Stockout ratio is another important measure of your efficiency, as it reflects your ability to deliver the right products to your customers at the right time. Therefore, there is a direct link between stockout ratio and customer satisfaction.

Shortage of stock means loss of sales. Not only for you, but also for your clients, if they are businesses. If poor optimization of your supply chain causes your customers to lose money, you may see your order book shrink.

This poses a significant challenge for the financial well-being of your business in the short, medium and long terms.

The more frequently you run out of stock, the higher the stockout ratio. Contrary to the turnover ratio, then, you need to keep this ratio as low as possible. It’s essential to monitor stocks on a regular basis, in particular by means of a physical inventory.

To calculate the stockout ratio, divide the number of orders not met due to stockout by the total number of orders placed. Here again, you can calculate this ratio as an annual figure.

Some stock shortages are more damaging than others, e.g. those affecting  products that are very expensive or time-consuming to produce - and therefore to restock. The amount of stock held in your warehouse is a factor, therefore.

When you draw up your stock forecasts, you have to prioritize products according to their importance (demand, restocking times, prices etc.), then make sure you hold enough buffer stock in each category of products to guarantee an excellent OTD rate.

Stock turnover is a useful indicator for analysing the performance of a supply chain.

If your ratio is too low relative to your sector of activity, optimizations need to be made. Calculating the stockout ratio also helps you determine if your supply chain is performing well.