Question

Williams & Sons last year reported sales of $20 million, cost of goods sold (COGS) of $16 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 8 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

Answer:

Cash will be freed up: $2,000,000

Explanation:

Inventory turnover ratio is calculated by using following formula:

Inventory turnover ratio = Cost of Goods Sold/Average Inventory

Average Inventory = Cost of Goods Sold/Inventory turnover ratio

Last year, Williams & Sons had sales of $20 million, cost of goods sold (COGS) of $16 million, and an inventory turnover ratio of 4.

Average Inventory = $16,000,000/4 = $4,000,000

For the new inventory system, inventory turnover ratio is 8 while maintaining the same level of sales and COGS.

Average Inventory = $16,000,000/8 = $2,000,000

Cash will be freed up = $4,000,000 - $2,000,000 = $2,000,000