The Percentage of Inventory to Total Assets
Analyzing certain ratios generated from financial reports provides insight into the financial health and viability of a business. These ratios may provide information for stakeholders within a company or those outside, such as lenders, shareholders or potential buyers. Common financial ratios include such comparisons as return on investment, debt to equity and return on assets. There are several types of ratios, grouped by the area of financial performance that each analyzes. These include groups of ratios such as profitability, liquidity, leverage and efficiency. Included in the last group is the ratio of inventory compared with total assets.
The percentage of inventory to total assets is one way to assess how the value of inventory impacts a company's financial performance. Other ratios used for similar analysis include current, quick and inventory turnover ratios.
Any ratio is calculated with a simple division equation. In the case of inventory to total assets, the calculation is:
(Value of inventory/Value of total assets) x 100
There are several sources for the information needed to calculate this ratio. These include:
- The balance sheet, which typically includes inventory amounts as well as total assets
- Working capital reports that include inventory, a capital asset tied up in earning money for the company
- Annual reports that include the value of total assets, as well as usually including a balance sheet, which provides inventory amounts
A single ratio is of little use without some point for comparison. For example, the inventory-to-asset ratio for one company could be compared with that of others in the same industry. Generally, the lower the ratio, that is, the smaller the amount of inventory is when calculated as a percentage of total assets, the better that company’s inventory efficiency.
As well as comparisons with other businesses, inventory to asset ratios may be compared over various time periods within one company to gauge how inventory efficiencies change over time. If the inventory to asset ratio falls over time, the company’s inventory efficiency increases, while a climbing ratio may indicate a decrease in efficiency, without extenuating reasons for the larger levels of inventory.
When comparisons show that the inventory to total assets ratio is high, certain general conclusions can be made. Compared to a similar business with a lower ratio, cash flow may be impeded due to the value of inventory. This could lead to increased financing costs to cover day-to-day cash needs. As a result, a high inventory to total assets ratio may raise questions about other aspects of a company’s health.
Excess inventory runs the risk of obsolescence. Holding a large stock of last year’s hot smart phone, for example, could lead to valuation losses in the face of updated technology.
Where inventory is perishable, large stocks could lead to loss through spoilage if inventory turnover rates are miscalculated. Large inventories may also be susceptible to shrinkage - loss from inventory theft.