Stock Turn Rate is an inventory ratio based on retail sales and indicates how well the merchandise inventory is performing. Since it compares net sales (a retail number) to average inventory at retail, it is a quantitative measurement of merchandise performance. Just like in school, the higher the number, the better the performance.
The formula for Stock Turn Rate (STR) is:
STR = Annual 12-months Net Sales / Average Inventory
The formula is very straight-forward except average inventory. The best method is to use the Beginning Inventory from each month (BOM) plus the Ending Inventory (EOM) of the last month, divided by 13 (Method 1-See below). There are some who consider the “average inventory” to be the inventory at the beginning of the year plus the inventory at the end of the year, divided by 2 (Method 2-See below). This method of calculation overlooks the many fluctuations in inventory that naturally occur during a year. The illustrations follow.
AVERAGE BOM INVENTORY AT RETAIL-Method 1
FEB BOM: 210,000
MAR BOM: 220,000
APR BOM: 250,000
MAY BOM: 200,000
JUN BOM: 175,000
JUL BOM: 160,000
AUG BOM: 205,000
SEP BOM: 215,000
OCT BOM: 250,000
NOV BOM: 290,000
DEC BOM: 215,000
JAN BOM: 190,000
JAN EOM: 165,000
The average inventory is the sum of all the above divided by 13 or 211,154. Applying the formula above and using the net sales of 750,000, the Stock Turn Rate is 3.55 (750,000 / 211,154).
AVERAGE BOM INVENTORY AT RETAIL-Method 2
FEB BOM: 210,000
JAN EOM: 165,000
The average inventory is (210,000+165,000)/2 or 187,500. Applying the formula for STR and using reported net sales of 750,000, the Stock Turn Rate would be 4.0.
The effect on the Stock Turn Rate calculation is a 0.45 turn difference. In this case, the correct calculation shows a slower stock turn rate. The standard calculation of Stock Turn Rate is based over a twelve month period just like the Open-To-Buy.
A Stock Turn Rate of 2.00 means there is a 6-month supply of inventory. A Stock Turn Rate of 1.0 means that a full year of planned sales is carried in inventory. An inventory of 0.50 means there is a 2-year supply of merchandise carried in inventory. You know how much you have invested in your inventory. Imagine the difference in a year’s supply and a 6-month supply or better yet a 4-month supply.
What Stock Turn Rate Is Not
Stock turn rate is not Inventory Turn Rate. Inventory Turn Rate is a financial ratio based on Inventory Cost from the Balance Sheet and Cost of Goods Sold from the Income Statement. Cost of Good Sold includes freight, discounts on merchandise invoices (2% in 10 days) and shrinkage, etc. It is not a pure representation of just the inventory items sold. Further, Inventory Turn looks at performance at a single point in time, like the end of the fiscal year.
A retail business gets its profit from the merchandise it sells from inventory. Stock Turn Rate measures the efficiency of the managing and selling of that inventory. The more liquid the merchandise, the less funds are committed to inventory at any point in time. Stock Turn Rate also helps the business owner determine how they can increase their sales through inventory control. Generally, a high Stock Turn Rate means that the company is efficiently managing and selling its inventory.
It is a balancing act. Stores must have adequate stock on hand for customer choices but not so much that it leads to storing inventory. Of course, there are times a company may be holding a lot of inventory for legitimate reasons such as a holiday shopping season or a big anniversary sale. Generally, the higher the STR is, the stronger your retail business will be. With a higher STR, you will have less money invested in inventory and a lower risk of carrying items that your customers do not want to buy.
Advantages of a faster Stock Turn Rate
First, a higher Stock Turn Rate reduces the cost of storing the merchandise. Fewer fixtures, hangers, insurance, taxes, etc. reduces costs and increases profit, as long as selling remains constant. It also helps to prevent obsolescence and promotes customers visits because the inventory is new and fresh regularly. Naturally, if there is less merchandise left at the end of a season, there are fewer markdowns.
Limitations of a faster Stock Turn Rate
Getting merchandise in more frequently will increase merchandise costs. If you receive 6 smaller shipments instead of 2 large ones, it stands to reason that shipping costs will be higher. Plus, there is more time needed for orders to be placed and bills to be paid. Finally, there is a danger of lost sales due to being out of stock.
Stock Turn Rate Details
Inventory storage or overhead costs include cost of money (interest on letters of credit, credit cards, loans, etc.), obsolescence (style, color or fit changes to name a few), shrinkage (stains, theft, etc.), technological or price obsolescence, taxes, insurance, space, manpower, record keeping, material handling and storage, inventory reconciliations (it takes more time to find all those older items stored in the back room), and energy. All of this equates to approximately 2.5% per month. Merchandise stored from one year to the next incurs costs of about 30% of the original cost of the item. Here’s the math: If you bought 30 suits for $100 each ($3,000 for the suits) and marked them to sell for $200 each, then sold only 8, the carrying costs, (storage costs or overhead costs) for keeping the other 22 suits until next fall is 22*.3*100 or $660 or $30 per suit per year. If it takes you 5 years to sell the last suit, that suit has incurred overhead charges of $150 plus the initial cost of $100. Can you sell the suit five years later for $350? That’s what you need to recoup your costs and earn the originally planned profit.
Merchandise that turns over only once a year has higher storage costs than items that turn over once a quarter. The purpose of increasing Stock Turn Rate is to reduce inventory levels and keep your inventory fresh with frequent receipts of new merchandise so customers will come back more often, knowing there will be something new to look at. Increasing inventory turns reduces overhead. The store spends less money on insurance, theft and other costs associated with maintaining merchandise.
Reducing overhead increases both net income and profit as long as sales remain constant. Items that turn over more quickly can address changes in customer wants while allowing for the replacement of obsolete items.