Question

Problem 16-01

Inventory Management Williams & Sons last year reported sales of $23 million, cost of goods sold (COGS) of $18 and an inventory turnover ratio of 2. The company is now adopting a new inventory system. If the new system is able to reduce the firm's inventory level and increase the firm's inventory turnover ratio to 6 while maintaining the same level of sales and COGS, how much cash will be freed up? Do not round intermediate calculations. Round your answer to the nearest dollar.

Answer 1

Sol:

Sales = $23 million

Cost of goods sold (COGS) = $18 million

Inventory turnover ratio = 2

New inventory turnover ratio = 6

Old inventory = COGS / Inventory turnover ratio

Old inventory = $18 million / 2 = $9 million

.

Now if the company adopt a new inventory system it will increase the firm inventory turnover ratio to 6

New inventory = COGS / New inventory turnover ratio

New inventory = $18 million / 6 = $3 million

Cash freed up = Old inventory - New inventory

Cash freed up = $9 million - $3 million = $6 million.

Therefore if the company adopts new inventory system then amount of cash freed up will be $6 million.