The word earnings to inventory ratio identifies some calculation which permits a management team to know the degree of inventory needed hand to encourage earnings. The metric takes the provider ‘s yearly price of goods sold and divides it from year end inventory.
Sales to Inventory Ratio = Cost of Goods Sold / Inventory
- The price of goods sold will probably soon be an amazing value, which is a year end figure or every 12 month interval.
- The degree of inventory uses has to align with precisely the exact same interval usedto find out the annualized cost of products sold.
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 a business should encourage a given amount of earnings is by calculating its sales to inventory ratio.
Calculating the sales to inventory ratio makes it possible for an organizations fund team to fully grasp just how much cash is going to be tangled up in inventory to support sales in their merchandise. The calculation employs historical price of goods sold and divides by the end inventory for precisely the same expiry period. The consequence of the calculation may be that the amount of times inventory turns over annually. The worth is advantageous not merely as a reference, but in addition to figure out the degree of inventory needed if a big change in overall earnings is prediction.
Company ABC conducted an effective promotional tool which forecasters believe will lead to a lasting increase into earnings. The CFO might really like to comprehend just how much additional cash will probably be assigned to inventory moving ahead. She wanted to guarantee that the organization wasn’t holding excess inventory. She asked her analytical team to compare the last two year’s sales to inventory ratios. The finance team put the following table together.
|Prior Year||Current Year|
|Cost of Goods Sold||$123,840,000||$148,608,000|
|Sales to Inventory Ratio||6.5||5.2|
The analysis revealed the company was holding excess inventory. If last year’s inventory was at the historical 6.5 level, Ending Inventory should have been $5,678,000 lower than its current level. Based on this information, the CFO set up a meeting with the COO to discuss her perceived over-inventory finding.