Managing inventory levels for companies that sell goods is a significant task. A company needs to maintain optimal inventory levels because having too much inventory increases cost such as storage, wear and tear, and interest. In addition, capital which could have been used for other income generating investments is tied up. On the other hand, having inadequate inventory may lead to loss of revenue because the company may not be able to meet demand.
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This creates the need to constantly monitor the inventory so that there are no shortage and excesses. It is also worth mentioning that inventory management has a direct effect on the working capital and liquidity of a business. Therefore, failure to manage it may also affect other aspects of the business and the day-to-day operations. In addition, the company can fail to raise adequate cash flow that can pay immediate obligations. One tool that the company can use to monitor inventory level is the inventory turnover ratio. This ratio works together with days in inventory. This paper seeks to carry out a comparative analysis of the two ratios for Amazon.com, Inc. and Wal-Mart Store, Inc.
This ratio is arrived at through the division of cost of sales and average inventory. Further, it gives information on the number of times a company replenishes stock in the year and the liquidity of inventory. A high inventory turnover ratio is often preferred because it shows that minimal funds are tied up in inventory. In addition, it also shows that a company has minimal storage costs. An extremely high value of inventory turnover ratio is also not favorable because it could imply that the company does not have enough stock that can meet demand.
In addition, it indicates that the company is spending a lot of reordering costs. Therefore, the company can lose sales opportunities due to shortages. On the other hand, low inventory turnover ratio implies that a company takes long before it replenishes stock. It can also indicate that the company is dealing with slow moving goods. It is worth mentioning that obsolete stock can also lead to low inventory turnover ratios (Goyal & Goyal, 2013).
Inventory turnover ratio depends on purchases of stock and sales. For instance, if a company buys a large amount of stock then it will have to make a large amount of sales so as to improve the turnover ratio. Therefore, sales have to match purchases so that the company can turn over effectively. Otherwise, the company may have unfavorable ratios. There are a number of factors that can affect the inventory turnover ratio. The first reason is obsolescence.
If a portion of inventory held by a company is out-of-date, then they cannot be sold. This will increase the inventory balance, thus reducing the value of inventory turnover ratio. Secondly, the inventory accounting method and price fluctuations can cause swings in the inventory balance. The use of either last-in-first-out, first-in-last-out, or weighted average in inventory valuation can affect the reported inventory balance and the turnover ratio. Finally, seasonal buildup can affect the value of the turnover ratio. For instance, stock of a product can build up ahead of the selling season. This can also distort the inventory turnover (Kimmel, Weygandt & Kieso, 2016).
The calculations for inventory turnover are presented in the attached excel file. The cost of sale for Amazon.com, Inc. was $62,752 million in 2014. The inventory balance of 2014 and 2013 were $8,299million and $7,411million respectively. Thus, the estimated value of inventory turnover ratio is 7.99 times. This implies that the company replenishes stock 7.99 times in a year. In the case of Wal-Mart Store, Inc., the cost of sales for 2015 amounted to $365,086.
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The inventory balance of 2015 was $45,141 million, while for 2014 amounted to $44,858million. The resulting value of inventory turnover is 8.11 times. A comparison of the two companies shows that Wal-Mart Store, Inc. had a slightly higher level of inventory turnover than Amazon.com, Inc. This implies that the company replenishes stock faster than Amazon.com, Inc. The industry average for inventory turnover is 8.4 times.
It signifies that the rate at which the two companies turns inventory is lower than the industry average. It is worth mentioning that the inventory turnover ratio varies from one industry to another because the industries sell different products. For instance, companies that sell fast moving stocks such food items are likely to have a high inventory turnover ratio as compared to entities that sell heavy machinery and equipment. This explains why it is important to compare the ratios calculated for a company with the specific industry average rather than general averages (Kimmel et al., 2016).
Days in Inventory
The ratio is arrived at through the division of 365 days in a year by the inventory turnover ratio. This ratio gives information on the duration of time inventory is held in the business. In the case of Amazon.com,Inc., the days in inventory was 45.69 days, while the ratio for Wal-Mart Store, Inc. was 44.99 days. The ratio shows that the average time that inventories spend on the shelf of Wal-Mart Store, Inc. is shorter than the duration they spend at Amazon.com, Inc. The industry average for days in sales is 43.5 days. This implies that stock takes a much longer time in the store of the companies than the average level in the industry (Kimmel et al., 2016).
Inventory turnover ratio and days in inventory are good indicators of how an entity effectively controls its merchandise. A comparison of the two companies shows that Wal-Mart Store, Inc. is more efficient in inventory management than Amazon.com, Inc. This can be attributed to the high inventory turnover ratio and low day in inventory. The ratio analysis also shows that the inventories for Wal-Mart Store, Inc. are more liquid than those of Wal-Mart Store, Inc. The efficiency in the management of inventory at Wal-Mart Store, Inc. can be attributed to the sophisticated inventory tracking and distribution system that enables the company to maintain reasonable levels of inventory balances, while still ensuring that there is adequate stock for customers.
This resonates with the contemporary business world where businesses invest heavily in systems and technology to monitor the movement of inventory. However, the efficiency in the management of inventory for the two companies was lower than the industry average. Therefore, the two companies need to review their policies and processes with an aim of improving efficiency.
Goyal, V. K., & Goyal, R. (2013). Financial accounting (4th ed.). New Delhi, India: PHI Learning Private Limited.
Kimmel, P. D., Weygandt, J. J., & Kieso, D. E. (2016). Financial accounting: tools for business decision making (8th ed.). New Jersey, NJ: John Wiley & Sons, Inc.