Use the inventory turn formula (cost of goods sold divided by the average inventory values) to come up with the number of inventory turns for each business. Between 1999 and 2000, McDonald's had an inventory turn rate of 96.1549, incredible for even a high-turn industry such as fast food. This means that every 3.79 days, McDonald's goes through its entire inventory. Wendy's, on the other hand, has a turn rate of 40.073 and clears its inventory every 9.10 days.
This difference in efficiency can make a tremendous impact on the bottom line. By tying up as little capital as possible in inventory, McDonald's can use the cash on hand to open more stores, increase its advertising budget, or buy back shares. It eases the strain on cash flow considerably, allowing management much more flexibility in planning for the long term.
The Final Word on InventoryThe bottom line: Investors want as little money as possible tied up in inventory. It is fine to have a lot of inventory on the balance sheet if it is being sold at a fast enough rate there is little risk of becoming obsolete or spoiled. Great companies have excellent inventory handling systems so they only order products when they are needed - they never buy too much or too little of something. Businesses that have too much inventory sitting on the shelves or in a warehouse are not being as productive as they could be: had management been wiser, the money could have been kept as cash and used for something more productive.
This page is part of Investing Lesson 3 - Understanding the Balance Sheet. To go back to the beginning, see the Table of Contents. If you have already read this lesson, you can skip directly to the Balance Sheet Quiz.
McDonald's vs. Wendy's Inventory Turnover Calculation
|Inventory on Balance Sheet||$99,300,000||$82,700,000|
|Cost of Goods Sold on Income Statement||$8,750,100,000|
|Inventory on Balance Sheet||$40,086,000||$40,271,000|
|Cost of Goods Sold on Income Statement||$1,610,075,000|