Question

1. The Lauchli Co. showed the following data in its financial statements:

	2018	2017
Cost of goods sold	$1,400,000	$1,120,000
Beginning inventory	270,000	177,000
Ending inventory	407,000	270,000

1a. Compute days sales in average inventory for both years. Also compute the rate of change from 2017 to 2018. What can you infer from the trend?

1b. How would you interpret these results if the company sold fresh fruit and vegetables? What if they sold heavy equipment?

Answer 1

Days sales in average inventory = 365 / Inventory turnover ratio

where, Inventory turnover ratio = Cost of goods sold / average inventory

average inventory = (Beginning inventory + Ending Inventory) / 2

		2018	2017
A	COGS	1400000	1120000
B	Beginning inventory	270000	177000
C	Ending Inventory	407000	270000
D	Average Inventory (B+C)/2	338500	223500
E	Inventory turnover (A/D)	4.14	5.01
F	days sales(Inventory holding) (365/E)	88	73

Rate of change in days = (73-88)/73

= 15/73

=20.59

21%

This ratio indicates how fast inventory is sold. A high ratio is good from the viewpoint of liquidity and vice versa. A low ratio would signify that inventory does not sell fast and stays on the shelf or in the warehouse for a long time.

here in 2018 the ratio has gone lower which is not a good sign.

1(b) If the company sold fresh fruits and vegetables, then inventory holding ratio is much poor as vegetables and fruits has very lower shelf life and here inventory holding days is approx 90 days which is very poor.

If company sold heavy equipment then will be ok from the perspective of deteriorating/damage the product.