EM3087 - Examining Accounts: Business Ratios: Stock and Work in Progress - Low Stocks or Undervaluation

Some indication of the validity of the stock value can be gained by looking at the ratio of stock to purchases, (or purchases and on-costs, if they are included in the valuation). The formula is:

• Value of Stock X 365 / Value of Purchases = Number of days stock in hand

This tells us the number of days purchases which are on hand at the end of the year. Alternatively, we can look at stock turnover during the year. The formula is:

• Value of Purchases / Average Value of Opening and Closing Stock = Number of times stock turned over during year

This gives us the number of times the stock was turned over during the year. It will be high for a food retailer, but low for, say, a jewellers or an antiques dealer.

Nature of trade

Clearly the level of stock which a business holds at its accounting date will depend on the nature of trade. Factors you should bear in mind are-

• whether the trade is seasonal? A manufacturing or retail business whose sales peak at a certain time of the year will not have a consistent pattern of stock holding throughout the year. Low stock could merely be representative of the fact that the balance sheet is drawn up at the low point in the business cycle.
• whether there is a manufacturing process of some sort? The complexity of the manufacturing process will obviously affect the level of stock and work in progress. A business which can create its product in a matter of hours or days may be able to work on a very fast throughput of goods, especially if manufacture is to contract. It may be possible to retain fairly low stocks of unprocessed materials and of finished goods. However if the manufacturing process is particularly complicated, extreme examples would be ship or aircraft building, the stock and work in progress figure should be relatively high.
• what are the types of goods being traded in or manufactured? Stocks of perishable goods are bound to be kept to a low level to prevent wastage. Typically, you would expect to see less than fourteen days on hand. However a manufacturer or retailer who has to hold a very wide range of goods, whose manufacturing process is particularly complex, or who needs to retain large stocks of raw materials (possibly to even out price fluctuations or supply problems) would turn over stock much less frequently.

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• (This content has been withheld because of exemptions in the Freedom of Information Act 2000)

(This content has been withheld because of exemptions in the Freedom of Information Act 2000)

(This content has been withheld because of exemptions in the Freedom of Information Act 2000)