Question

Net operating cycle are more compara- whereas Buckeye +S4 million next ce Company is interested in reducing its investment in inventory to levels that are more o its competitors. Its competitors typically have 30 days of inventory on hand, whereas *U days on hand. Buckeye predicts that its average day's sales will remain at $4 million 29. Buckeye Tree Company is interested in reduc ble to those of its competitors. Its competi currently has 40 days on hand. Buckeye predic year. von hand, what do you expect the A. If Buckeye alters its inventory control to have only 30 days of invento change in inventory next year compared to the current year to be? Buckeye alters its inventory control to have only 30 days of inventory on hand, how will next periode inventory turnover compare to this period's?!

Answer 1

a: Having inventory on hand is an investment in working capital for a company and hence ties up funds. Companies should ideally aim to reduce working capital.

In the current scenario, Buckeye has 40 days worth of inventory which amounts to $160 million (40 x $4 million). Reducing the inventory days to 30 days would also reduce the amount of inventory to $120 million (30 x $4 million).

b: The inventory ratio is an efficiency ratio that shows how effectively a company is in managing its inventory. It is measured by the formula: Sales/ Inventory. Accordingly, a higher inventory ratio indicates higher efficiency.

In the prior period with 40 days of inventory, Buckeye would have an inventory turnover ratio of 9.125 (365 x 4)/ (40 x 4). On reducing the number of days to 30, the inventory turnover ration would improve to 12.16 (365 x 4)/ (30 x 4).

Note: For calculation of inventory turnover ratio, COGS can also be used in the numerator instead of the sales figure. Since the same is not available in this question, we are using Sales.