Question

What are some of the issues a company might face if they do not have enough inventory on hand and what ratio analysis might help management analyze inventory issues?

Answer 1

1.If the Company does not have enough inventory, they will not be able to fulfill the demand of its product leading to loss of revenue.

2.Their labor will also be sitting idle in the mean time leading to Wastage of resources.

3.Their Buyers will lose out on the confidence, that they will be serve according to their demand, which may lead to permanent decrease in product demand or severing of ties with the buyer.

4.Machinery may stop in case inventory is not there.Extra costs are involved in again getting to the 100% efficiency level as before.

Ratios that are helpful in analyzing Inventory for a Company,

1.Inventory turnover: Calculated as ratio of COGS to average inventory. It indicates how many times inventory balance is sold during the financial year. if it is increasing then it means that we should be more cautious in inventory management as we are processing it fast.

2.Inventory to sales ratio: ratio of inventory to revenue. tells us the growth in inventory in comparison to growth in sales. low growth in inventory in comparison to growth in sales means we need to increase our inventory buying to be at the same level

3.Days Inventory Outstanding: This ratio measures the average number of days Company holds the inventory before selling it.

If it is going down below the threshold that means we need to better manage our inventory. Inventory shortage could be seen if it goes too much below.

Calculated as Inventory/ COGS * 365