As three of America's leading retailers, Home Depot, Nordstrom, and Cold Water Creek, are responsible for over $80 billion in annual sales. Retail industry analysts look for commonalities in inventory management reporting in order to track company's ability to move inventory and maximize pricing strategies and avoid having to discount obsolescent inventory thus affecting profit. Through analysis of a company's inventory management ratio, outside investors and inside management can track the number of times each year a company turns its inventory. Industries such as retail are extremely sensitive to inventory management as many retail products have short shelf lives due to cyclical inventory and technological advances.
Through an analysis of each company's inventory methodology, it was discovered that all utilized the first in-first out (FIFO) method, which values inventory by applying a cost-to-retail ratio to the ending inventory's retail value that are common among U.S. retailers.
This paper explores three diverse retail businesses and their inventory methodologies. The first, Home Depot, is a warehouse type building, maintenance and home improvement store. Second, Nordstrom, an upscale department store is popular for its high-end apparel and renowned customer service. Lastly, Cold Water Creek, a women's apparel and accessory store that started with mail order, has moved into retail outlets in the last three years. Home Depot closed its 2004 fiscal year on January 30, 2005 while both Nordstrom and Cold Water Creek closed their 2004 fiscal year January 29, 2005. We examined the inventory costing method, the motivation for the choice, the inventory turnover ratio and the effect of the change in inventories on cash flow from operations.
All three retail companies use the First-In-First-Out (FIFO) inventory method for its stores. The FIFO method assumes that the earliest goods purchased are the first goods sold and the last goods purchased are left in ending inventory. FIFO allocates the oldest unit costs to cost of goods sold and the newest unit costs to ending inventory. Companies who select the FIFO inventory method typically have seasonal or cyclical items that will expire or spoil. All the retail companies examined for this paper have seasonal products making the FIFO inventory choice the best method.
Assuming an economy of consistently rising prices, last-in-first-out (LIFO) would yield a lower net income before taxes. It yields a lower net income because the most recent or higher priced items are sold first, leaving the earliest or lowest priced items in ending inventory. Since the higher priced items are sold first, the cost of goods sold increases, thus reducing net income.
Inventory Turnover Ratio
To evaluate the efficiency of the inventory management, the inventory turnover ratio measures the company's success in managing its inventory. The inventory turnover ratio reflects how many times the average inventory was produced and sold during the financial period. A higher ratio indicates that inventory moves more quickly through the production process to the customer, reducing storage and obsolescence costs. The inventory turnover ratio is the cost of goods sold divided by the average inventory. Of the three companies, Coldwater Creek, Inc. has the greatest turnover with a ratio of 5.74. Followed by Home Depot, Inc. with 5.1 and Nordstrom with 5.0 (See Figure 1).
Effect of the Change in Inventories on Cash Flow
For all companies, the change in inventory from the beginning of year to the end of the year is an increase. Purchases of inventory are going to affect the operations section of the cash flow section. An increase in inventory will yield a decrease in net cash flows from operating activities.
Through our in-depth analysis of the three above mentioned companies, it is apparent that each puts an emphasis on their inventory turnover ratio and...
References: Cold Water Creek. (2005). Retrieved on July 25, 2005 from
Home Depot, Inc. (2005). Retrieved on July 25, 2005 from http://www.homedepot.com/
Nordstrom. (2005). Retrieved on July 25, 2005 from http://library.corporate-
Retail industry profile. (2004). Retrieved August 1, 2005 from http://retailindustry.about.com/od/abouttheretailindustry/p/retail_industry.htm
Yahoo! Finance. (n.d.) Retrieved August 1, 2005 from http://finance.yahoo.com/q/pr?s=JWN.
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