Financial Well-Being

Question: The assertion was made that companies have vital signs that can be examined as an indication of financial well-being. These are ratios or other computed amounts

considered to be of particular significance. In that earlier coverage, the age of the receivables and the receivable

turnover were both calculated and explained. For inventory, do similar vital signs also exist that decision makers

should study? What vital signs should be determined in connection with inventory when examining the financial

health and prospects of a company?

Answer: No definitive list of ratios and relevant amounts can be identified because different people tend to have

their own personal preferences. However, several figures are widely computed and discussed in connection with

inventory and cost of goods sold when the financial condition of a company and the likelihood of its prosperity

are being evaluated.

Gross profit percentage. The first of these is the gross profit percentage, which is found by dividing the gross

profit for the period by net sales.

sales – sales returns and discounts = net sales

net sales – cost of goods sold = gross profit

gross profit/net sales = gross profit percentage

Previously, gross profit has also been referred to as gross margin, markup, or margin of a company. In simplest

terms, it is the difference between the amount paid to buy (or manufacture) inventory and the amount received

from an eventual sale. Gross profit percentage is often used to compare one company to the next or one time

period to the next. If a book store manages to earn a gross profit percentage of 35 percent and another only 25

percent, questions need to be raised about the difference and which percentage is better? One company is making

more profit on each sale but, possibly because of higher sales prices, it might be making significantly fewer sales.