You\'re the young financial forensic of a clothing retail company called The Sta

Question

You're the young financial forensic of a clothing retail company called The Station. You're in the middle of an analysis for your CEO who said, "Something is wrong with our operations. Take a look at it and tell me your thoughts." So here you are, eyes glued on the following information, Last Year This Year Monthly Cost of Good Sold 3,500,000.00 4,083,333.30 Average Inventory 6,000,000.00 7,000,000.00 You pushed the numbers and were surprised. What do you think was your CEO, a 20-year veteran talking about? What's wrong? Or, did he just simply loss his mind? Note: Remember, whatever you say will have an effect on your very young career

Explanation / Answer

Yes. There is a something wrong with company's operations. After analysing inventory turnover ratio(see w.n1) , inventory turnover ratio is same as it was last year i.e. 0.5833.

That is we have unnecessarily purchased inventory. By analysing with inventory turnover we can understand how efficiently a company is controlling it's merchandise of sale. Inventory turnover ratio should always be higher.

By current inventory ratio, a company will require approx more than 1 half year to sell total inventory but still company has purchased more inventory. Having more inventory in balance sheet is spending unnecessarily on purchasing an inventory. That is pure waste of resources.

Hence, contention of CEO is correct. Something is going wrong in company operations that unnecessarily purchases are made and sales are increased by that proportion only. It is not good sign.

Working note 1.:-

Inventory turnover ratio= COGS/ average inventory

Last year= 3500000/6000000= 0.5833

Current year= 4083333.3/7000000= 0.5833

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