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Also, from the most recent income statement, we might have the following figures (in thousands):

Net sales

$11,500

Cost of goods sold

8,200

We now need to calculate some financial ratios. We discussed these in some detail in Chapter 3; here, we just define them and use them as needed.

The Operating Cycle First of all, we need the inventory period. We spent $8.2 million on inventory (our cost of goods sold). Our average inventory was $2.5 million. We thus turned our inventory over $8.2/2.5 times during the year:2

Cost of goods sold

Average inventory

$8.2 million

2.5 million

3.28 times

2Notice that in calculating inventory turnover here, we use the average inventory instead of using the ending inventory as we did in Chapter 3. Both approaches are used in the real world. To gain some practice using average figures, we will stick with this approach in calculating various ratios throughout this chapter.

Ross et al.: Fundamentals I VII. Short-Term Financial I 19. Short-Term Finance I I © The McGraw-Hill of Corporate Finance, Sixth Planning and Management and Planning Companies, 2002

Edition, Alternate Edition

646 PART SEVEN Short-Term Financial Planning and Management

Loosely speaking, this tells us that we bought and sold off our inventory 3.28 times during the year. This means that, on average, we held our inventory for:

365 days

Inventory period —

Inventory turnover 365

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