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8.8 Sales to Inventory Ratio Analysis Questionnaire

What is the Sales to Inventory ratio and why is it significant for a small business like A Touch of Tuscany?

The Sales to Inventory ratio denotes the number of times the annual sales of a small business like A Touch of Tuscany is able to cover the inventory that the business holds on average. The analysis of this ratio is best done over time since the amount of times the sales of the company will be able to cover its inventory will vary with both the level of sales and the changing level of inventory. Generally speaking the higher the ratio of the Sales to Inventory, the better it is for the company since it shows a robust demand for its products and services

In the case of service oriented companies like realtors, or dentists, this number will not have much significance since service oriented businesses really don't have much of an inventory to speak of. They tend to have higher fixed costs with office space and staff and that is what needs to analyzed using different ratios.

Does a very high Sales to Inventory always mean that things are great for a small business like A Touch of Tuscany?

No. If the Sales to Inventory of a small business like A Touch of Tuscany is much higher than other similar businesses, then it could well indicate that the inventory levels of the small business are very low and the business may be running the risk of losing a large order in the event they carry a very lean inventory. In today's increasingly technologically driven business environment where even small to medium sized businesses are able to carry very lean inventories due to the improvements made in the inventory re-ordering systems, we find that more and more businesses rely on carrying low inventory levels to be able to keep their cash flow going. However this can always backfire.

Small businesses tend to wait all year long for that large order and finally when the order does come through, they often have to scramble to find the inventory and / or the ability to finance the inventory. In the event you are a small business carrying a very low inventory because you don't have much of a cash flow cushion, you may find it useful to go out and get business loan or line of credit or perhaps even some other form of trade financing, so that you can make an investment in an adequate amount of inventory.

Some businesses by their very nature have to carry a decent inventory or they can loose out easily to the competition next door - the car dealership business is a classic example. How many small new car dealers have you seen> - not many - unless they are used car dealerships. The reality in that business is that when the customers come to buy a car, they need to be able to see plenty of cars from which they can choose. If not the business can easily lose the business to a larger competitor down the street.

Why is the movement of Inventory so important to a small business like A Touch of Tuscany?

Cash is king and the only way to generate cash is to make the sale and collect from the customers. Successful small business owners like Jack Gordon know this and thus focus on moving the merchandise and booking sales rather than worrying about sticking to a certain price for their goods and services. Even in the sevices industry, booking the sale is much more important than worrying about price. We are not suggesting that small business owners not watch their margins and pricing, but we certainly don't recommend that they sacrifice sales and keep their valuable cash locked up in their inventories.

Additionally some industries have different dynamics than others. The retail jewellery industry has inventory that is of a very different nature than the fast food business or the apparel business. Anybody who has shopped for clothing knows that fashions change every season and hence the retailer has to focus on moving their merchandise since in a few months, their inventory will be useless. In other businesses like automotive repair, the inventory of parts is relatively small and durable - which is to say that it can last longer or in some instances only ordered from the dealer when there is a need.

A car dealer has to deal with a very different dynamic for their inventory - as the model year comes to a close in the summer, you will find that most car companies will start blowing out their inventories and offer steep incentives to customers to get the older models off their lots and make room for the next years models.

What can be identified by a decreasing Sales to Inventory Ratio and why should a business owner like Jack Gordon pay attention?

A declining Sales to Inventory ratio can be an indicator of future problems. It could mean a couple of things - firstly it could be an indicator that the sales of a small business like A Touch of Tuscany are declining or it could mean that the inventory is rising or both. Clearly depending on what the underlying causes are - further investigations will be warranted.

Thus if a small business owner like Jack Gordon sees his Sales to Inventory ratio decline, and upon further investigation finds that the sales are off, it may be indicative that something is wrong with the sales process. A new product may have been introduced that is not working well, in the case of service oriented businesses, a new manager or employee may be responsible for the loss in sales - the reason for the decline in Sales will have to be understood and then fixed by a small business owner like Jack Gordon.

On the other hand, if the decline in the ratio is being caused by an increase in the level of inventory, a small business owner will have to take a look at why the inventory has been rising - there may have been an incredible deal that the business was offered for a certain component from the wholesaler and the business decided to buy a lot of it for future use; or the prices of the raw materials could have gone up a lot resulting in higher inventory costs.

Quick Links:

  1. Go to the Corresponding Template section for this industry.
  2. Go to the Corresponding Business Plan section for this industry.

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