Evaluating the Effects of Manufacturing Changes on Inventory Turnover Ratio and Cash Flows from Operating Activities
Carter and Company has been operating for five years as an electronics component manufacturer specializing in cellular phone components. During this period, it has experienced rapid growth in sales revenue and in inventory. Mr. Carter and his associates have hired you as its first corporate controller. You have put into place new purchasing and manufacturing procedures that are expected to reduce inventories by approximately one-third by year-end. You have gathered the following data related to the changes:
| (dollars in thousands) | |
| Beginning | End of Year |
| of Year | (projected) |
Inventory | $595.700 | $394.310 |
|
| Current Year (projected) |
|
| |
Cost of goods sold |
| $7,008.984 |
Required:
1. Compute the inventory turnover ratio based on two different assumptions:
a. Those presented in the preceding table (a decrease in the balance in inventory).
b. No change from the beginning-of-the-year inventory balance.
2. Compute the effect of the projected change in the balance in inventory on cash flow from operating activities for the year (the sign and amount of effect).
3. On the basis of the preceding analysis, write a brief memo explaining how an increase in inventory turnover can result in an increase in cash flow from operating activities. Also explain how this increase can benefit the company.
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