Compute inventory turnover for 2005 and 2004. The inventory balance at December 31, 2003, was $294 million. Do the trend of net income from 2004 to 2005 and the change in the rate of inventory turnover tell the same story or a different story? Explain your answer.
To compute the inventory turnover for 2005 and 2004, we need two pieces of information: the cost of goods sold (COGS) and the average inventory balance for each year.
The formula for inventory turnover is:
Inventory Turnover = Cost of Goods Sold / Average Inventory
To calculate the average inventory, we need the inventory balance at the end of the previous year (December 31, 2003, in this case) and the inventory balance at the end of the current year (December 31, 2004 and 2005).
Let's assume the information for COGS and inventory balances is available for each year:
Year 2004:
COGS = X million dollars
Average Inventory = (Opening Inventory Balance + Closing Inventory Balance) / 2
= ($294 million + Closing Inventory Balance in 2004) / 2
Inventory Turnover for 2004 = COGS / Average Inventory
Year 2005:
COGS = Y million dollars
Average Inventory = (Opening Inventory Balance + Closing Inventory Balance) / 2
= (Closing Inventory Balance in 2004 + Closing Inventory Balance in 2005) / 2
Inventory Turnover for 2005 = COGS / Average Inventory
Now, to analyze the trend of net income and the change in the inventory turnover rate:
1. Net Income Trend:
Compare the net income for 2004 and 2005. If the net income increased from 2004 to 2005, it suggests a positive trend. Conversely, if the net income decreased, it suggests a negative trend.
2. Inventory Turnover Rate:
Compare the inventory turnover rate for 2004 and 2005. If the inventory turnover rate increased from 2004 to 2005, it suggests that the company is selling goods at a faster rate. Conversely, if the inventory turnover rate decreased, it suggests that the company is selling goods at a slower rate.
Now, to answer whether the trend of net income and the change in the inventory turnover rate tell the same story or a different story, we look for correlations between the two:
- If the net income and inventory turnover rate both increased, it suggests a positive correlation. This could indicate that the company's sales are increasing, resulting in higher net income, and the inventory turnover is also improving, meaning the company is efficiently managing its inventory.
- If the net income increased, but the inventory turnover rate decreased or remained unchanged, it suggests a negative correlation. This could indicate that the company's sales are growing, leading to higher net income, but the inventory turnover is not improving, implying inefficient inventory management.
- If the net income decreased, but the inventory turnover rate increased, it suggests a negative correlation. This could indicate that the company's sales are declining, resulting in lower net income, but the inventory turnover is improving, which might suggest effective inventory management despite lower sales.
In summary, the trend of net income and the change in the rate of inventory turnover can tell the same story or a different story, depending on the correlations observed. It is essential to analyze both factors to gain a holistic understanding of the company's financial performance and how it is managing its inventory.