Question

Inventory Management

Williams & Sons last year reported sales of $55 million, cost of goods sold (COGS) of $45 million, and an inventory turnover ratio of 5. 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 9 while maintaining the same level of sales and COGS, how much cash will be freed up? Do not round intermediate calculations. Enter your answer in dollars. For example, an answer of $1.23 million should be entered as 1,230,000,000. Round your answer to the nearest dollar.

Answer 1

The amount of cash is computed as shown below:

Inventory when inventory turnover is 5 is computed as follows:

Inventory turnover = Cost of goods sold / Average Inventory

5 = $ 45 million / Average inventory

Average inventory = $ 45 million / 5

= $ 9 million

Inventory when inventory turnover is 9 is computed as follows:

Inventory turnover = Cost of goods sold / Average Inventory

9 = $ 45 million / Average inventory

Average inventory = $ 45 million / 9

= $ 5 million

So, the amount of cash freed up is computed as follows:

= $ 9 million - $ 5 million

= $ 4,000,000

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