LOS L requires us to:
analyze and compare the financial statements of companies, including companies that use different inventory methods.
We can get a lot of information regarding the inventory and its management from the disclosures made in financial statements as per the GAAP and IFRS. Some of the information and their respective interpretations are as follows:
a. We can get information regarding the carrying amount and classification (into raw material, work in progress, and finished goods) of inventory. These figures themselves can provide a lot of information, before even calculating the ratios out of them.
b. A rise in raw material and work in progress may suggest an increase in demand, requiring higher production of finished goods.
c. On the contrary, an increase in the stock of finished goods coupled with a decrease in the levels of raw material and work in progress, may indicate a decrease in demand. It may also signal a future write-down of the value of inventory.
d. If there is a growth in inventory and this growth is greater than the growth in sales, then it may indicate a decrease in demand.
e. Thus, rising inventories can indicate future possibilities of write-downs, the higher period cost for storage and insurance, and lesser cash for other purposes.
While comparing the figures and ratios of different companies also we should not just jump over to conclusions just by looking at the figures and ratios. We should further look at the driving force for such ratios. For example, if the inventory to total assets ratio is higher for a company we should not directly jump over to conclusions that the company with a higher ratio is more efficient. What if, the company with the lower ratio was using the LIFO method of inventory valuation, and the lower ratio was a result of the difference in technique?