Question

3. Asset management ratios

Asset management ratios are used to measure how effectively a firm manages its assets.

Remember, there are two slightly different equations that can be used to evaluate the management of a firm’s inventory. In either case, the inventory management ratio puts the inventory balance in the denominator and either its corresponding Sales value or the corresponding Cost of Goods Sold (COGS) value in the numerator. In the first (older) sales-based computation, the ratio identifies the number of sales dollars generated with each dollar of inventory held. The second, newer equation—which places COGS in the numerator—compares the costs of producing the firm’s goods with the amount of inventory held. Don’t forget that the components of COGS are direct materials, direct labor, and the overhead associated with producing the firm’s goods and services. Therefore, the COGS-based version of the ratio compares the firm’s inventory with its costs, whereas the Sales-based version compares the inventory balance with the firm’s revenues and profits.

Now, consider the following case:

Mall Toys Co. has a quick ratio of 2.00x, $37,575 in cash, $20,875 in accounts receivable, some inventory, total current assets of $83,500, and total current liabilities of $29,225. The company reported annual sales and cost of goods sold of $100,000 and $70,000, respectively, in the most recent annual report.

Over the past year, Mall Toys Co. sold and replace its ? x   times this year (using the sales-based inventory turnover ratio) and ? times per year (using the COGS-based ratio).

The sales-based inventory turnover ratio across companies in the industry is 4.39x. Based on this information, which of the following statements is true for Mall Toys Co.?

a.Mall Toys Co. is holding more inventory per dollar of sales compared to the industry average.

b.Mall Toys Co. is holding less inventory per dollar of sales compared to the industry average.

Answer 1

sol.) Quick ratio is the financial ratio that test companies liquidity in respect of its current or short term liabilities. it states how much cash needed in order to meet the liabilities.

The company has a quick ratio of 2.

Therefore,  

hence, marketable securities = 2* current liabilities - cash in hand - trade receivables = 2 * 29225 - 37575 - 20875=0

Therefore, the inventory = current assets - quick ratio * current liabilities = 83500 - 2*29225 = $25050

Therefore, company's sales based inventory turnover ratio = Annual sales / inventory = 100000 / 25050 = 3.99

similarly, Company' cost of goods sold inventory turnover ratio = cogs / inventory =70000 / 25050 = 2.794

a.) The statement "Mall Toys Co. is holding more inventory per dollar of sales compared to the industry average." is correct statement because the sales-based turnover ratio for Mall toys co is less than the industry' average inventory turnover ratio which signifies that the Mall toys is holding more inventory as it need to be in order to obtain industry's turnover ratio.

b.) The statement "Mall Toys Co. is holding less inventory per dollar of sales compared to the industry average." is incorrect because the sales-based turnover ratio for the company is less than industry' average