Question

Williams & Sons last year reported sales of $32 million, cost of goods sold (COGS) of $24 million, and an inventory turnover ratio of 4. 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. Enter your answer in million, rounded to two decimal places. For example, an answer of $1.23 million should be entered as 1.23.

Answer 1

We know that:

Inventory = cost of goods sold / inventory turnover ratio

Inventory_OLD = cost of goods sold / old inventory turnover ratio

Inventory_OLD = $24 million / 4 = $6 million

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

Inventory_NEW = cost of goods sold / new inventory turnover ratio = $24 million / 6 = $4 million

Cash Freed up = Old Inventory Level - New Inventory Level = $6 million - $4 million = $2 million

$2.0 million of cash will be freed up.