Question

 

 

 

Assume sales increase by 10% next year, and COGS (costs of goods sold) drops to 80% of sales. If the company increases its inventory ratio to 5:4, how much cash is generated from the reduction in inventory?

Answer 1

Current inventory turnover ratio, T1 = Cost of goods sold/Inventory = 6300000/1260000 = 5.00

Let next year inventory turnover ratio = T2

 

Then, T2/T1 = 5/4

or, T2 = (5/4)*T1 = (5/4)*5.00 = 6.25

 

Next year sales = (1+10%)*Current year sales = (1+10%)*7000000 

                                                                                  = 7700000

 

Next year cost of goods sold = 80%*Next year sales 

                                                    = 80%*7700000 

                                                    = 6160000

 

Therefore, next year inventory = Next year cost of goods sold/T2 

                                                       = 6160000/6.25 

                                                        = 985600

 

Therefore, cash generated from reduction in inventory = Current year inventory-Next year inventory 

                                                                                                   = 1260000-985600 

                                                                                                   = 274400

Cash generated from reduction in inventory is $274400.