Lesson 8 of 8 · All lessons in this module
- Inventory cost formulas and inventory systemsVideo lesson
- Rising and falling costs: effects on statements and ratiosVideo lesson
- The LIFO reserve, LIFO-to-FIFO conversion and LIFO liquidationVideo lesson
- Measuring inventory: lower of cost and net realisable valueVideo lesson
- Inventory write-downs: effects on ratios and analysis
- Inventory disclosures, ratios and analyst checks
- Integrated cases: reading the inventory note and restating to one basis
- Integrated cases: a two-year ratio panel and 'what if the cost formula changed'
Lesson 8 of 8 · 15 min
Integrated cases: a two-year ratio panel and 'what if the cost formula changed'
A full ratio panel is computed in a fixed order, then read as one story: activity, profitability, liquidity and solvency each explain part of what changed, and the cost formula or write-downs can move all of them.
In short
- Compute the same six ratios for each year from the statements: inventory turnover, days on hand, gross margin, current ratio, debt-to-equity and ROA on average assets.
- Average-based ratios need three year-end balances for a two-year panel; do not use ending figures when the definition says average.
- Strip write-downs out before judging turnover: they raise turnover and lower margins, so the underlying decline in efficiency is larger than reported.
- A cost-formula what-if is a direction question: under rising costs weighted average gives higher cost of sales, lower inventory and lower profit than FIFO, so margin, current ratio and ROA fall while turnover rises.
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