Lesson 5 of 8 · All lessons in this module
- Inventory cost formulas and inventory systemsVideo lesson
- Rising and falling costs: effects on statements and ratiosVideo lesson
- The LIFO reserve, LIFO-to-FIFO conversion and LIFO liquidationVideo lesson
- Measuring inventory: lower of cost and net realisable valueVideo lesson
- Inventory write-downs: effects on ratios and analysis
- Inventory disclosures, ratios and analyst checks
- Integrated cases: reading the inventory note and restating to one basis
- Integrated cases: a two-year ratio panel and 'what if the cost formula changed'
Lesson 5 of 8 · 12 min
Inventory write-downs: effects on ratios and analysis
A write-down lowers profit and assets, so it hurts profitability, liquidity and solvency ratios but flatters activity ratios; an analyst can undo it using the valuation allowance disclosed in the notes.
In short
- A write-down raises cost of sales (lower profit) and cuts inventory (lower current and total assets).
- Hurt: profitability (margins, ROA), liquidity (current ratio) and solvency (debt-to-equity rises as equity falls).
- Flattered: activity ratios such as inventory turnover and total asset turnover, because the asset base shrinks.
- Inventory at cost = reported inventory + valuation allowance. Cost of sales without write-downs = reported cost of sales − increase in the allowance (+ decrease).
- LIFO companies are less likely to need large write-downs when costs have risen, because LIFO inventory is already carried at old, low costs.
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