1.Evaluating Inventory Productivity As CEO, you are also concerned about making
ID: 375777 • Letter: 1
Question
1.Evaluating Inventory Productivity
As CEO, you are also concerned about making sure you have enough cash on hand to run the business. One of the biggest users of your cash flow is inventory, and you would like to evaluate how productive various products are in their use of inventory in terms of annual inventory turns.
Below are the relevant figures on sales, product margin (sales less cost of goods as a % of sales), and inventory levels (valued at manufacturing cost. Which is giving you a more productive use of its inventory? Why?
Product A
Product B
Sales $
$ 5,000,000
$ 7,500,000
Gross Margin %
45%
30%
Average Inventory $
$ 2,750,000
$ 5,250,000
Product A
Product B
Sales $
$ 5,000,000
$ 7,500,000
Gross Margin %
45%
30%
Average Inventory $
$ 2,750,000
$ 5,250,000
Explanation / Answer
Groos margin for Product A is 0.45*5000000 = 2250000 And for Product B the gross margin is 0.3*7500000 = 2250000. So both contribute to same gross profits although the sales are high for product B.
Inventory turn over ratio for Product A = Sales/Avg Inventory
= 5000000/2750000
= 1.82
Inventory turn over ratio for Product B = 7500000/5250000
= 1.33
Better the turnover ratio, lesser is the holding cost, higher is the conversion/utilization of inventory into sales.
In this scenario, although Product B generated good sales volume, the profit and inventory utilization is poor compared to Product A. Product A utilized inventory effectively as it can be easily witnessed in the inventory turnover ratio. Higher the ratio, better is the capability of effective utilization of inventory.
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.