Inventory to Working Capital Ratio

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The ratio of inventory to working capital tells you how much of a company’s inventory is paid for by its working capital. Working capital is the amount of money a company has available to meet its short-term financial obligations, such as paying bills and salaries. Inventory is the stock of goods that a company has on hand to sell.

In other words, the ratio of inventory to working capital measures how much of a company’s cash is tied up in inventory. A lower ratio is generally better, as it indicates that the company is not investing too much money in inventory. This can free up more cash for the company to use to grow its business. It is important to note that the ideal ratio can vary depending on the industry.

Here is an example:

1. A company has $1 million in inventory is paid for and $2 million in working capital.
2. The ratio of inventory is paid for to working capital is $1 million / $2 million = 0.5.
3. This means that 50% of the company’s inventory is paid for by its working capital.

A lower ratio of inventory is paid for to working capital is generally better, as it indicates that the company is not investing too much money in inventory. This can free up more cash for the company to use to grow its business. It is important to note that the ideal ratio can vary depending on the industry.

How is it calculated?

The inventory to working capital ratio is calculated by dividing the inventory is paid for by the working capital value.

The formula is as follows:

Inventory to working capital ratio = Inventory is paid for/ Working capital

Where

Inventory is paid for:

Inventory is paid for = Inventory value - Accounts payable

Working capital:

Working capital = Current assets - Current liabilities

Current assets: Cash, accounts receivable, inventory, and other short-term assets that can be converted into cash within one year.

Current liabilities: Accounts payable, short-term debt, and other short-term obligations that must be paid within one year.

For example, if a company’s paid for inventory is $100,000 and working capital of $200,000, its inventory to working capital ratio would be 0.5. This means that the company has 50 cents of inventory for every dollar of working capital.

What does it tell you about a company?

The inventory to working capital ratio is a financial ratio that measures how much inventory a company has relative to its working capital. Working capital is a company’s current assets minus its current liabilities. Inventory is a company’s current asset that includes the goods that a company has on hand for sale.

The inventory to working capital ratio can tell you a lot about a company, including:

1. How well the company manages its inventory.
2. How much cash the company has tied up in inventory.
3. The company’s risk of financial problems.
4. The company’s customer service levels.

A high inventory to working capital ratio indicates that a company is holding too much inventory. This can be a sign of poor inventory management or a sign that the company is anticipating a surge in demand. A low inventory to working capital ratio indicates that a company is not holding enough inventory. This can be a sign of good inventory management or a sign that the company is not anticipating enough demand.

A company should monitor its inventory to working capital ratio and take steps to improve it if it is out of line. A high or low ratio can indicate potential problems with inventory management. Companies should also consider other factors, such as the industry they are in and the company’s overall financial health, when interpreting the inventory to working capital ratio.

Here are some examples of how the inventory to working capital ratio can be used to analyze a company:

1. A company with a high inventory to working capital ratio may be at risk of financial problems. This is because a high inventory level can tie up a company’s cash, making it difficult for the company to meet its financial obligations.
2. A company with a low inventory to working capital ratio may be losing sales. This is because a low inventory level can lead to stockouts, which can frustrate customers and cause them to buy from competitors.

Here is a table that shows the inventory to working capital ratio for a company and how it can be interpreted:

It is important to note that the inventory to working capital ratio is just one measure of inventory management. Companies should also consider other factors, such as the industry they are in and the company’s overall financial health, when interpreting the inventory to working capital ratio.

Conclusion:

The inventory to working capital ratio is a useful formula for assessing a company’s inventory management practices. A high or low ratio can indicate potential problems with inventory management. Companies should monitor their inventory to working capital ratio and take steps to improve it if it is out of line.