Inventory to working capital ratio is a liquidity ratio that measures the amount of working capital that is tied up in inventory. Working capital is the difference between current assets and current liabilities, and it represents the funds that keep the business running daily. Inventory is the stock of goods that a company has on hand to sell.
This ratio can help investors and managers assess how well a company manages its inventory and how much cash it has available to meet its short-term obligations. A lower ratio is generally preferable, as it indicates that the company is not investing too much money in inventory and has more cash to grow its business. A high ratio may suggest that the company is holding too much inventory that is slow to sell or obsolete, and has less cash to pay its bills and salaries.
The formula for inventory to working capital ratio is:
Example
Let’s say we want to calculate the inventory to working capital ratio for a company that has the following financial data:
- Inventory: $500,000
- Accounts Receivable: $300,000
- Accounts Payable: $200,000
Using the formula, we can compute the ratio as:
This means that 83% of the company’s working capital is tied up in inventory. This is a relatively high ratio, which may indicate that the company has a lot of inventory that is not selling fast enough or is outdated.
Excel Formula
To calculate the inventory to working capital ratio in Excel, we can use the following formula:
=Inventory/(Accounts_Receivable+Inventory-Accounts_Payable)
We can enter the values of inventory, accounts receivable, and accounts payable in separate cells, and then use cell references in the formula. For example, if we enter the values from the previous example in cells A1, A2, and A3, respectively, we can enter the formula in cell A4 as:
=A1/(A2+A1-A3)
This will give us the same result of 0.83.
Excel Table
We can also use an Excel table to calculate the inventory to working capital ratio for multiple companies or periods. To do this, we can follow these steps:
- Create a table with the headers Inventory, Accounts Receivable, Accounts Payable, and Inventory to Working Capital Ratio in row 1, and enter the values for each company or period in the subsequent rows.
- Select the table and go to the Insert tab and click on Table.
- Check the box that says My table has headers and click OK.
- In the cell under the header Inventory to Working Capital Ratio, enter the formula
=[@Inventory]/([@Accounts Receivable]+[@Inventory]-[@Accounts Payable])and press Enter. - The formula will be automatically copied to the rest of the column, and the table will display the ratio for each row.
Here is an example of an Excel table with the inventory to working capital ratio for four companies:
| Inventory | Accounts Receivable | Accounts Payable | Inventory to Working Capital Ratio |
|---|---|---|---|
| 500,000 | 300,000 | 200,000 | 0.83 |
| 400,000 | 250,000 | 150,000 | 0.67 |
| 300,000 | 200,000 | 100,000 | 0.5 |
| 200,000 | 150,000 | 50,000 | 0.33 |
Alternative Approaches
There are some alternative ways to calculate the inventory to working capital ratio, depending on how we define working capital. One common approach is to use the net working capital, which is the difference between current assets and current liabilities. In this case, the formula is:
Another approach is to use the operating working capital, which is the difference between current assets and non-interest-bearing current liabilities. In this case, the formula is:
Non-interest-bearing current liabilities include accounts payable, accrued expenses, and taxes payable, but exclude short-term debt and current portion of long-term debt.
These alternative approaches may give different results than the original formula, depending on the composition of the current assets and liabilities. Therefore, it is important to be consistent and transparent when using the inventory to working capital ratio, and to compare it with the industry average or the company’s historical trend.
