Now sometimes when they give you the inventory turnover ratio, they might just give you one number for inventory, they may not say beginning inventory and ending inventory. Right? So that's how we're always going to calculate the average. Just like you see up here, right? The average inventory, that's the beginning inventory plus the ending inventory divided by two. So we're gonna do that first, we're gonna add those together and then we're gonna divide by two. Okay, and the average balance, we're always going to calculate it the same way we're gonna take the beginning balance in that account plus the ending balance in that account. Okay, In a lot of ratios we use this average balance idea. Well it equals cost of goods sold divided by average inventory. So let's look how we calculate this ratio right here. Right? So we want to basically manage that as well as possible. If we sell t shirts we've got boxes of t shirts sitting in a warehouse. Remember when we have inventory, it costs us money to store whatever boxes. So we're trying to see how efficiently we use our inventory. Um But the inventory turnover ratio, this is a really common efficiency ratio that you study in this class. So we'll discuss this in a little more detail. So the inventory turnover ratio, this is going to relate the amount of cost of goods sold, cost of goods sold to average inventory levels. As with any ratio, comparison should also be made to competitor and industry ratios, while consideration should also be given to other factors affecting the company’s financial health, as well as to the strength of the overall market economy.Alright now let's discuss another ratio. This ratio is useful to identify cases of obsolescence, which is especially prevalent in an evolving market, such as the technology sector of the economy. This result would alert management that it is taking much too long to sell the inventory, so reduction in the inventory balance might be appropriate, or as an alternative, increased sales efforts could turn the ratio toward a more positive trend. Year 2’s number of days’ sales in inventory ratio increased over year 1’s ratio results, indicating an unfavorable change. The result for the Spy Who Loves You indicates that it would take about 307 days to clear the average inventory held in year 1 and about 433 days to clear the average inventory held in year 2. The number of days’ sales in inventory ratio is calculated by dividing average inventory by average daily cost of goods sold. The insights gained from the ratio analysis should be used to augment analysis of the general strength and stability of the company, with the full data available in the annual report, including financial statements and notes to the financial statement.Įxcerpts from Financial Statements of The Spy Who Loves You Company: Once calculated, these ratios should be compared to previous years’ ratios for the company, direct competitors’ ratios, industry ratios, and other industries’ ratios. Ratio analysis is used to measure how well management is doing at maintaining just the right amount of inventory for the needs of their particular business. Too little inventory means lost sales opportunities, whereas too much inventory means unproductive investment of resources as well as extra costs related to storage, care, and protection of the inventory. Inventory is a large investment for many companies so it is important that this asset be managed wisely. Mitchell Franklin Patty Graybeal and Dixon Cooper LO 7.5 Examine the Efficiency of Inventory Management Using Financial Ratios
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