Financial Ratio Analysis - Stock Turnover: stock control

Stock Turnover: stock control

In principle, the lower the investment in stocks the better. Apart from buffer stocks that businesses sometimes need in case of shortages of supply and strategic stocks in case of war, sudden changes in demand and so on, modern stock control theory tells us to minimise our investment in stocks.

Let's see how the Carphone Warehouse behaves in this respect.

The formula for this ratio is:

Stock Turnover =     Average Stocks    
(Cost of Sales/365)

Carphone Warehouse
Consolidated Profit and Loss Account
31 March 2001 25 March 2000
  £'000 £'000
Cost of sales 830,126 505,738
Stock 52,437 51,842

Stock Turnover Ratio for the Carphone Warehouse
31 March 2001 52,437
830,126 / 365
23.06 days
25 March 2000 51,842
505,738 / 365
37.42 days

If you use alternative formulae and are happy with them, that's fine. If you think you need help because of that, see your teacher/lecturer for guidance.

  • Firstly, the result of this calculation is that the answer is instantly in terms of the number of days, on average, that the stocks are held in the business.
  • Secondly, we use the cost of sales figure because stocks are bought and shown in the profit and loss account and the balance sheet at cost; so we need to compare like with like.
  • Thirdly, we only have two years' worth of stock information, so we can't use the average stock for both years as we should do according to the formula. Never mind, even though the answer won't be 100% spot on, it will give us a very good estimate of how stock control is going.

How can we interpret this ratio? With a result of 23.06 days, we can imagine that we bought our £52,437,000 worth stocks of raw materials or whatever they were on 1st January 2002. We then know that we ran out of those raw materials on 1 + 23.06 days = just into 25th January.

Similarly with the result of 37.42 days, if we bought our £51,738,000 worth of raw materials on 1st January, we would run out and have to buy some more on 7th February.

This ratio has fallen from 37 days to 23 days over the two years and that is probably a good thing. If there's less stock to worry about, lower investment in stocks meaning that the money they used to have tied up in the stock room is now free to spend somewhere else.

In fact, stocks have remained at around £52 million as we mentioned before, but the cost of sales has increased by 64% over the two years. Put these two facts together and that explains the improvement in this ratio.

Well done the Carphone Warehouse!

Remember that we talked about the liquidity of stocks when we discussed the acid test ratio. Now we can see that the Carphone Warehouse's stocks are fairly liquid, since a turnover ratio of 23 days isn't too bad!

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