• STOCK TURNOVER RATIO, also known as INVENTORY TURNOVER, is a financial metric that 'MEASURES HOW MANY TIMES A COMPANY'S INVENTORY IS SOLD and REPLACED over a specific time period', typically a year. The formula for stock turnover is:

--STOCK TURNOVER = COGS / AVERAGE INVENTORY--

• COGS = The total cost of producing or purchasing the goods that a company has sold* during a period. (*Obviously It is only stock that has been sold needs replacing)

• AVERAGE INVENTORY = Inventory can vary throughout the year, for example when it is school holidays, or Christmas time etc therefore In order to 'smooth out fluctuations' we work out the average stock, which can be calculated in units or $-value

AVERAGE INVENTORY = (Opening Inventory + Closing Inventory) / 2

• WORKED EXAMPLE: 

  • • • "If at the start of the year you have $100 worth of stock,...

      • ...and only $50 worth of stock at the end of the year then the average stock you hold is worth $75 ($150/2)...

      • ...and if in that time you COGS is equal to $300 worth of stock it would imply that to maintain this $75 worth of stock you would have had to replace it on 4 occasions" 

      • Start with $75, sell $75, reorder $75, sell $75, reorder $75, sell $75, reorder $75, sell $75, reorder $75

• BECAUSE IT INDICATES THAT SALES ARE GOOD: Clearly the high rate must indicate that the products are 'flying off the shelf'. Though the firm must be careful not to 'Sell out' and miss sales opportunities.

• BECAUSE IT INDICATES THAT THE FIRM CAN MANAGE ITS INVENTORY: Clearly a high rate shows that the firm has a well-implemented and smooth inventory system.

• BECAUSE IT MEANS THE FIRM IS GENERATING CASH FLOW: Faster inventory turnover IMPROVES CASH FLOW, as products are sold quickly, generating revenue that can be reinvested in the business.

• BECAUSE IT SHOULD LOWER STORAGE COSTS: High turnover reduces storage costs, minimizes the risk of inventory obsolescence, and lowers the chances of spoilage, especially for perishable goods. Though of course ordering and shipping costs will rise.

• BECAUSE IT HELPS IDENTIFY BEST SELLING PRODUCTS: It helps identify products that sell well and contribute more to profits, guiding better pricing and marketing strategies.

• INCREASE COGS:

  • • • INCREASE SALES through promotions, discounts, etc... or diversify product offerings based on customer demand.

• LOWER AVERAGE STOCK:

  • • • REDUCE STOCK using Just-In-Time (JIT) inventory.

      • IDENTIFY & DISCONTINUE OBSOLETE INVENTORY of items with declining demand.

• Explain why a fresh-fish retailer would (hopefully) have a much higher stock turnover ratio than a car dealer and explain why it has little relevance to TES.

• DEBTOR DAYS measures HOW LONG ON AVERAGE IT TAKES FOR A FIRM TO GET PAID BY CUSTOMERS WHO HAVE BOUGHT GOODS 'ON CREDIT'. 

• The formula for debtor days is:

AVERAGE DEBTOR DAYS = AVERAGE TRADE RECEIVABLES ($) / TOTAL CREDIT SALES ($) * 365

• AVERAGE TRADE RECEIVABLES = The amount OWED BY CUSTOMERS ('Yet to be received') can vary throughout the year, for example when the shop has a big sale 'Black Friday' etc... a large amount of credit is given, therefore In order to 'smooth out fluctuations' we work out the average trade receivables, which usually is calculated $-value like so:

  • • AV. RECEIVABLES = (Opening receivables + Closing receivables) / 2

• CREDIT SALES = Sales made on credit (not cash sales).

• WORKED EXAMPLE: "If your business's average receivables is $50m and has made $500m worth of credit sales by the end of year, we can say that on average you must have waited ($50/$500 * 365) = 36.5 days for each payment to be paid up.

• CAN CREATE CASH FLOW PROBLEMS: If customers take too long to pay, you MIGHT RUN OUT OF CASH TO PAY YOUR OWN BILLS, STAFF, or SUPPLIERS—even if your business is making a lot of sales. This is turn puts off investors who see the business as too risky.

• INDICATES POTENTIAL DEFAULTS: Rising debtor days can signal trouble, like customers struggling to pay, which could lead to bad debts (money you never get back).

• DECREASE SALES RECEIVABLES:

  • • • REDUCE REPAYMENT PERIOD e.g from 60 days to 30 days

      • CLEARLY STATE DEADLINES IN ALL DOCUMENTS/INVOICES

      • OFFER EARLY PAYMENT DISCOUNTS

      • ADD & CONSISTENTLY ENFORCE LATE PAYENT FEES

      • TIGHTEN CUSTOMER CREDIT CHECKS

      • GIVE CREDIT LIMITS, e.g only offer 50% pay later instead of 100%

      • SEND REMINDERS

      • OFFER VARIOUS CLEAR PAYMENT OPTIONS

• Imagine that TES currently allows parents a 2-MONTH CREDIT TERM. Explain WHY as financial controller you might wish to change this, and SUGGEST THREE METHODS you might use.

• CREDITOR DAYS measures HOW LONG ON AVERAGE IT TAKES FOR A FIRM TO PAY ITS SUPPLIERS WHO THEY HAVE BOUGHT GOODS FROM 'ON CREDIT'. 

• The formula for creditor days is:

AVERAGE CREDITOR DAYS = AVERAGE ACCOUNTS PAYABLE ($) / TOTAL COGS of CREDIT PURCHASES ($) * 365

• AVERAGE ACCOUNTS PAYABLE = The amount OWED BY YOU ('Yet to be paid') can vary throughout the year, for example when the shop has a big sale 'Black Friday' etc... a large amount of purchases are made on credit to meet demand, therefore In order to 'smooth out fluctuations' we work out the average accounts payable, which usually is calculated $-value like so:

  • • AV. PAYABLES = (Opening payables + Closing Payables) / 2

• CREDIT PURCHASES = Supplies bought by you on credit.

• WORKED EXAMPLE: "If your business's average payables is $50m and has made $500m worth of credit purchases by the end of year, we can say that on average you wait ($50/$500 * 365) = 36.5 days to pay of your accpunts payable.

• LONGER DAYS IMPROVES CASHFLOW as the company holds on to more cash for a longer period, which means they have access to short -term financing for other needs.

• HOWEVER, this MAY PUT A STRAIN ON SUPPLIER RELATIONSHIPS as timely payments maintain strong relationships with suppliers, potentially leading to better credit terms, discounts, or priority service, so asking for longer days may LOSE THE SUPPLIER'S GOODWILL.

• SHORTEN SALES RECEIVABLES:

  • • • REDUCE REPAYMENT PERIOD e.g from 60 days to 30 days

Optimize receivables and inventory turnover to ensure sufficient cash for timely payments.

Automate Payment Processes:

Use accounting software to streamline invoice approvals and avoid delays.

Negotiate Early Payment Discounts:

Take advantage of discounts offered by suppliers for early payments, reducing costs.

Budget for Payables:

Integrate payment schedules into cash flow forecasts to ensure funds are allocated for upcoming dues.

TO EXTEND

Negotiate Better Payment Terms: 

Work with suppliers to secure longer payment periods without affecting relationships.

Consolidate Suppliers:

Leverage bulk purchasing power to negotiate favorable credit terms.

Optimize Working Capital:

Align payment schedules with receivables to maintain liquidity while extending creditor days.

Build Strong Supplier Relationships:

Reliable partnerships may allow more flexible credit arrangements, especially during tight cash flow periods.

Key Point:

While extending creditor days can improve liquidity, excessive delays may harm supplier relationships. The goal is to strike a balance that supports both operational efficiency and strong supplier partnerships.

•  THE GEARING RATIO  measures HOW MUCH OF A COMPANY'S FINANCING COMES FROM DEBT COMPARED TO EQUITY. It shows the company’s financial risk as THE HIGHER THE GEARING THE MORE THE COMPANY RELIES ON DEBT, which can be risky if profits fall.

• The formula for the gearing ratio is:

GEARING RATIO = NON-CURRENT LIABILITIES / CAPITAL EMPLOYED * 100

• NON-CURRENT LIABILITIES = Long-term debt (loans, bonds, etc.)

• CAPITAL EMPLOYED = NON-CURRENT LIABILITIES + Equity

A HIGH RATIO is not desirable because...

• HIGHER DEBT REPAYMENTS: The obvious concern about a high gearing ratio (>50%) is GREATER INTEREST REPAYMENTS that need to be met regardless of how well the company is doing, unlike shareholder equity that requires no payments.

• LESS ATTRACTIVE TO AN INVESTOR: In addition these interest payments have an opportunity cost in the form of less DIVIDENDS or RETAINED PROFITS.

A LOW RATIO whilst safe is possibly not desired also because...

• MANAGEMENT ARE NOT SEEKING RAPID GROWTH: An unwillingness to take on debt may suggest that the company is considered 'too risk-averse' and not aggresive enough in pursuing rapid growth.

• SELL MORE SHARES to INCREASE CAPITAL EMPLOYED via EQUITY

• RETAIN MORE PROFITS to DECREASE NON-CURRENT LIABILITIES

• SELL ASSETS to DECREASE NON-CURRENT LIABILITIES