4.17) Calculating and interpreting inventory turnover ratios. Dell produces comp

Question

4.17) Calculating and interpreting inventory turnover ratios.

Dell produces computers and related equipment on a made-to- order basis for customers and businesses. Sun Microsystem design and manufactures high-end computers that function as servers and for use in computer-aided design. Sun Microsystem sells primarily to businesses. It also provides services to business customers in addition to product sales of computers. Selected data for each firm for three recent years appear in exhibit 4.24. (Dell’s fiscal year-end is in January; Sun’s fiscal year-end in June, subsequently in 2010, Oracle acquired Sun).

                                                       

                                                                  Year 3                                year2              year1

Dell

Cost of goods sold                                    $49,375                         $48,855          $47,433

Average inventories                                     1,024                                920                  618

Change in sales from previous year             + 1.1%                             + 3.3%             +4.4%

Sun Microsystem

Cost of goods sold                                          $5,948                               $6,639               $6,778

Average inventories                                               623                                   602                    532

Change in sales from previous year              -     10.4%                               -2.1%                 +3.7%

Required

a)       Calculate the inventory turnover ratio for each firm for the three years.

b)      Suggest reasons for the differences in the inventory turnover ratios of these two firms.

c)       Suggest reasons for the changes in the inventory turnover ratios during the three-year period.

Explanation / Answer

a) Inventory turnover ratio = Cost of goods sold/Average inventories

Calculation of Inventory turnover ratios of Dell for 3 years

Calculation of Inventory turnover ratios of Sun Microsystem for 3 years

b) Inventory turnover ratios of Dell for 3 years are vey much higher in comparison to Inventory turnover ratios of Sun Microsystem due to fact that Dell has maintained a very low inventory in comparison to cost of goods sold than Sun Microsystem.

c) Sun Microsystem's sales is continuously falling from year 1 to year 2 to year 3 and hence cost of goods sold is also falling. On the other hand, average inventory is rising every year. Hence, falling cost of goods sold and rising inventory levels have caused inventory turnover ratios of Sun Microsystem to decrease year to year.

Inventory turnover ratio of Dell is also decreasing year by year. This is because average inventory is increasing faster in comparison to cost of goods sold and hence reducing inventory turnover ratio every year.

Year Cost of goods sold (i) Avergae inventories (ii) Inventory turnover ratio (i)/(ii) Year 1 $47,433 $618 47,433/618 = 76.75 times Year 2 $48,855 $920 48,855/920 = 53.10 times Year 3 $49,375 $1,024 49,375/1024 = 48.22 times

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