Chapter 7, Problem 7.7CP

Comparing inventory ratios for three companies

The general merchandise retail industry has a number of segments represented by the following companies:

Company Name	Merchandise Concept
Costco Wholesale Corporation	Membership warehouse
Wal-Mart	Discount general merchandise
JCPenney Company	Department store

For a recent year, the following cost of merchandise sold and beginning and ending inventories have been provided from corporate annual reports (in millions) for these three companies:

	Costco	Wal-Mart	JCPenny
Cost of merchandise sold	$101,065	$365,086	$8,074
Merchandise inventory, beginning	8,908	45,141	2,721
Merchandise inventory, ending	8,456	44,858	2,652

1. a. Determine the inventory turnover ratio for all three companies. Round to two decimal places.
2. b. Determine the days’ sales in inventory for all three companies. Use 365 days and round to one decimal place.
3. c. Interpret these results based on each company’s merchandise concept

To determine

Inventory turnover ratio: Inventory turnover ratio is used to determine the number of times inventory used or sold during the particular accounting period. The formula to calculate the inventory turnover ratio is as follows:

$\text{Inventory turnover}=\frac{\text{Cost of goods sold}}{\text{Average inventory}}$

Days’ sales in inventory: Days’ sales in inventory are used to determine number of days a particular company takes to make sales of the inventory available with them. The formula to calculate the days’ sales in inventory ratio is as follows:

$\text{Days' sales in inventory}=\frac{\text{Days in accounting period}}{\text{Inventory turnover}}$

To determine: the inventory turnover for Company C, Company W and Company JC

Answer to Problem 7.7CP

The inventory turnover ratio for Company C is calculated is calculated as follows:

$\begin{array}{c}\text{Inventory turnover}=\frac{\text{Cost of goods sold}}{\text{Average inventory}}\\ =\frac{\$101,065}{8,682\left(1\right)}\\ =11.64\text{ Times}\end{array}$

Working notes:

The average inventory is calculated as follows:

$\begin{array}{c}\text{Average inventory}=\frac{\left(\begin{array}{l}\text{Inventory, beginning of the year + }\\ \text{Inventory, end of the year}\end{array}\right)}{2}\\ =\frac{\left(8,908+8,456\right)}{2}\\ =8,682\end{array}$ (1)

The inventory turnover ratio for Company W is calculated is calculated as follows:

$\begin{array}{c}\text{Inventory turnover}=\frac{\text{Cost of goods sold}}{\text{Average inventory}}\\ =\frac{\$365,086}{44,999.50\left(2\right)}\\ =8.11\text{ Times}\end{array}$

Working notes:

The average inventory is calculated as follows:

$\begin{array}{c}\text{Average inventory}=\frac{\left(\begin{array}{l}\text{Inventory, beginning of the year + }\\ \text{Inventory, end of the year}\end{array}\right)}{2}\\ =\frac{\left(44,858+45,141\right)}{2}\\ =44,999.50\end{array}$ (2)

The inventory turnover ratio for Company JC is calculated is calculated as follows:

$\begin{array}{c}\text{Inventory turnover}=\frac{\text{Cost of goods sold}}{\text{Average inventory}}\\ =\frac{\$8,074}{2,686.5\left(3\right)}\\ =3.01\text{ Times}\end{array}$

Working notes:

The average inventory is calculated as follows:

$\begin{array}{c}\text{Average inventory}=\frac{\left(\begin{array}{l}\text{Inventory, beginning of the year + }\\ \text{Inventory, end of the year}\end{array}\right)}{2}\\ =\frac{\left(2,721+2,652\right)}{2}\\ =2,686.5\end{array}$ (3)

Explanation of Solution

The inventory turnover ratio is calculated by dividing cost of goods sold by average inventory during the period. The average inventory is calculating by dividing beginning inventory and ending inventory by 2. The inventory turnover ratio is an important measure as to how efficient is the management is good at managing inventory and achieving sales from it.

Conclusion

The inventory turnover of Company C is 11.64 Times, the inventory turnover of Company W is 8.11 Times & the inventory turnover of Company JC is 3.01 Times.

To determine

the Days’ sales in inventory ratio for Company C, Company W and Company JC.

Answer to Problem 7.7CP

The Days’ sale in inventory ratio for Company C is calculated is calculated as follows:

$\begin{array}{c}\text{Days' sales in inventory}=\frac{\text{Days in accounting period}}{\text{Inventory turnover}}\\ =\frac{365}{11.64}\\ =\text{31}\text{.4 days}\end{array}$

The Days’ sales in inventory ratio for Company W is calculated are calculated as follows:

$\begin{array}{c}\text{Days' sales in inventory}=\frac{\text{Days in accounting period}}{\text{Inventory turnover}}\\ =\frac{365}{8.11}\\ =\text{45}\text{.0 days}\end{array}$

The Days’ sales in inventory ratio for Company JC is calculated are calculated as follows:

$\begin{array}{c}\text{Days' sales in inventory}=\frac{\text{Days in accounting period}}{\text{Inventory turnover}}\\ =\frac{365}{3.01}\\ =121.6\text{ days}\end{array}$

Explanation of Solution

The Days’ sales in inventory ratio are calculated by dividing days in accounting period by inventory turnover ratio. The Days’ sale in inventory ratio is an important measure to know how long the company is holding the inventory before selling when compared to its peers.

Conclusion

The Days’ sales in inventory of Company C is 31.4 days, the Days’ sales in inventory of Company W is 45.0 days, & the Days’ sales in inventory of Company JC is 121.6 days.

To determine

To interpret: the above calculated ratios.

Explanation of Solution

The inventory turnover ratio and number of days’ sales in inventory of all the three companies reflect the merchandising approaches of all companies. Company C is a club warehouse and it has approach of holding only items which are quickly sold. Most of the items are sold in bulk at very attractive prices.

In case of company W, it has a traditional discounter approach. Even though it has attractive pricing, the inventory movement is slower than in the case of company C.

In the case of company JC, it is a high-end fashioner retailer. It offers a wide collection of specialty and unique goods that are specifically designed for fashion market rather than for general mass market. Therefore, the movement is slower than other two companies yet it has highest margin.