Inventory to sales ratio is calculated by dividing the total inventory for the month divided by the totals sales for that month. The Inventory to Sales Ratio measures how many months it would take to use up the surplus supplies held on shelf at that monthly sales rate. An inventory to sales ratio of 2. 1 means that it will take 2. 1 months to clear the whole inventory. A low inventory to sales ratio is a good indicator for the economy as it signifies that sales are growing more rapidly than the inventories.
When this ratio is low business tend to increase their sales by pacing up their manufacture process and order. For that reason a falling inventory to sales ratio points out the fact that the business environment is improving. Moreover a low inventory to sales shows that the inventory is lessening relative to sales or that sales are increasing, either ways this a positive sign for a business as it shows that inventory and cash is being managed resourcefully.
However a mounting inventory to sales ratio shows that inventory is rising quicker than sales, which means that businesses are being piled up with unnecessary inventory. The action taken to reduce the storage of inventory is slowing the speed of the manufacturer process and delaying orders. The outcome of a high inventory to sales ratio is slow economic activity which leads to falling interest rates and inflation. An upward trend of the ratio indicates that the business condition is worsening.
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The factors responsible for a low inventory to sales ratio can be accounted to technology as it reduces the delivery time and results in better management of the inventory levels that lessens the need for excessive stocks in warehouses. Just in time method of inventory management leads to the less need for stockpile up. If inventory is closely lined with sales then variation in GDP and inventory will be minimized. The trend for declining of the inventory to sales ratio is likely to continue in the future due to reason such as the Just in time method of managing inventory , which helps in reducing the huge chunk of stocks to be stored.
JIT has a lot of cost cutback and lead time diminution. In addition due to continuous improving technology people are more likely to rely on low levels of inventory. Also, due to valuable and efficient logistic and supply chain management there is less need to mount up current assets in inventory. Additionally the benefits derived from having low ratio level is immense, as it enables businesses to invest their extra cash in short term investments which enables the investments to be used up more efficiently.
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