Question

Answer each of the questions in the following unrelated situations.

b) A company had an average inventory last year of $200,000 and its inventory turnover was 5. If sales volume and unit cost remain the same this year as last and inventory turnover is 8 this year, what will average inventory have to be during the current year?

Short answer

The average inventory is $125,000.

Step-by-step solution

Meaning Inventory Turnover Ratio

The inventory turnover ratio can be found by dividing the cost of goods sold by average inventory. It is a useful indicator of a company's ability to convert inventory into sales.

Determining the average inventory during the current year

$\begin{array}{rcl}\mathrm{Cost}\mathrm{of}\mathrm{goods}\mathrm{sold}& =& \mathrm{Average}\mathrm{inventory}\times \mathrm{Inventory}\mathrm{turnover}\\ & =& \$200,000\times 5\\ & =& \$1,000,000\\ \mathrm{Inventory}\mathrm{turnover}\mathrm{ratio}& =& \frac{\mathrm{Cost}\mathrm{of}\mathrm{goods}\mathrm{sold}}{\mathrm{Average}\mathrm{inventory}}\\ & =& \frac{\$1,000,000}{8}\\ & =& \$125,000\end{array}$

Hence, the average inventory = $125,000