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Inventory to Working Capital Ratio Definition

Definition

The word inventory to working capital ratio identifies some calculation which makes it possible for an investor-analyst to grasp the capacity of a business to raise extra cash from working capital. This metric can be found together with additional metrics such as inventory turnover.

Calculation

Inventory to Work Capital Ratio = Inventory / Working Capital

Where:

  • Working capital is defined as accounts receivable and inventory minus accounts payable.

Explanation

Liquidity measures allow the investor-analyst to comprehend the provider ‘s long term viability concerning financial wellbeing. That is generally evaluated by examining balance sheet items such as accounts receivable, usage of inventory, accounts receivable, and also shortterm obligations. One of those techniques to comprehend just how much cash is raise together with working capital is by simply calculating the inventory to working capital ratio.

Calculating the inventory to operational capital ratio makes it possible for an organizations fund group, or investor-analyst, to fully grasp just how much cash may be increased by the business with its operational funds. By way of instance, if your business includes a relatively significant ratio, then it might be more difficult to convert working funds into money. That is particularly valid if the firm ‘s inventory turnover ratio can also be relatively small, which might indicate an excessive amount of cash is tied up in inventory. When potential, the investor-analyst should benchmark the mark company against its competitors. At precisely the exact same style, the ratio needs to be assessed versus additional inventory metrics.

Example

The director of a big mutual fund might love to comprehend how simple it really is for Company ABC to boost funding from working. He asked his analytic team to calculate Company ABC’s inventory to working capital ratio. The team had benchmarked Company ABC’s inventory turnover ratio (5.2), that has been below the market average of 6.0. The director ‘s team expressed the advice below from the latest SEC filings.

Prior Year Current Year
Ending Inventory $19,052,000 $28,578,000
Accounts Receivable $36,600,000 $54,900,000
Accounts Payable ($14,640,000) ($19,215,000)
Working Capital $41,012,000 $64,263,000
Inventory to Working Capital Ratio 0.46 0.44

The study showed Company ABC had a relatively large percentage of working capital tied up in inventory. Based on this advice, in conjunction with the relatively minimal stock turnover worth, the mutual fund manager chose to have a better look at quite a few additional liquidity metrics for Company ABC before investing choice.