Adding Tools to Your Mental Toolbox: Accounts Receivable, Inventories & Sales

 *Sales/Inventory = Inventory Turnover
NOTE: (Beginning of the period inventory + End of period inventory /2) will also lead to more accurate interpretation of seasonal inventory levels.

“An investment in knowledge pays the best interest.” – Benjamin Franklin Image

I like to think of learning, educational material, events experienced, physically practising activities, reading and watching videos as tools that produce intangible pockets of wisdom to be kept in your mental tool box. When it comes to fundamentally assessing a public company, there is many steps involved, from initial scans, to basic ratios and financial statement analysis, the process can be intimidating.

But it is your hard earned money that you haven chosen to invest and partake in future profits the company delivers and it is your duty to conduct diligent research or pay someone else to do so. Whenever you are buying, someone is selling. Whenever you are selling, someone is buying. It is best to take this into consideration when doing your research because you are essentially telling the market you know more.

Why is Inventory Analysis important?

Excessive inventories produce additional carrying costs, which in turn hurt COGS as well as increase the exposure of write offs (damage & shrink). When inventory trends higher in relation to the companies sales, write offs and markdowns can occur quickly, negatively impacting earnings.

Bloated inventories can also reveal slowing production in the near future. Although finished goods, raw materials and work in progress (WIP) are the better items to scrutinize reported in the 10-Q or 10-K (if available for SEC reporting). When finished goods are being produced at a higher or unsustainable rate in comparison to sales and raw materials, it is a red flag that production is on the verge of decline. On the other hand as raw materials and sales increase in relation to finished goods, production is likely to increase in the near term.

Inventory represents an investment by the business that currently is earning 0% ROR (rate of return) and is an asset that must be managed efficiently. I find this analysis works best in consumer sensitive, technology, and industrial cyclical companies. Comparisons are best completed peer to peer within the same industry for obvious industry differences. Inventory management is crucial in business as cash is tied up and inventory must be produced within moderate accuracy of sales outcomes (not forecasts) or blunders may occur.

I highly recommend adding this tool to your list of ratios when analyzing potential investments or operating your own business, efficiency is one of the golden keys of business success.

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