Reference no: EM133166558
Reply to this post agree or disagree
Inflation can have significant effects on income statements and balance sheets, and therefore on the calculation of ratios. Discuss the possible impact of inflation on the following ratios:
- Return on investment
- Inventory turnover
- Fixed asset turnover
- Debt-to-assets ratio
Also explain the direction of the impact based on your assumptions.
Inflation in economics means an overall generalization where prices of goods and services increase. Therefore, consumers' ability to purchase goods and services are reduced. While in theory inflation increases prices of goods and services which would increase the nominal return on investment (assets, ROI/ROA). However, this is false because for example if a bond investment was earning at 4% last year and inflation was 7%. This scenario highlights the fact while you nominally gained 4% but because inflation is 7%, your actual return on investments is -3%. Translation, if your initial investment was $100, with 4% earning it is worth $104 but can only buy $97 worth of goods and services because inflation is at 7%. Inventory Turnover ratio measures the amount of inventory a business sells over a time. Depending on the rates inflation will result in two outcomes for Inventory Turnover ratio. First, if a business believes high inflation is coming then the business will stockpiling inventory thus decreasing the ratio in a form of hedging, buying products at low cost, and selling at higher prices to increase profit margins. Second, for example hyperinflation in Venezuela since 2014 creates shortages as consumers expect continuing trends of inflation which results in Increasing Inventory Turnover ratio. Consumer rationalized extreme spending as a form of hedging against the devaluation of the currency to obtain as many goods and products as possible while money still holds its current value. The fear of missing out or the hot potato theory (last person holding the hot potato) is what drives the increase inventory turnover ration as stores and businesses are not able to rise prices fast enough to prevent hording. The fixed-asset turnover (FAT) ratio would trend higher during inflation because net sales are recorded at record high price levels while the average net fixed assets are logged historical low prices. The debt-to-asset ratio represents the company's uses of debt to finance the assets. For example, if the ratio is 0.35 this means the amount of assets financed by creditors are 35% compared to 55% financed by owners/shareholders. When Sears declared bankruptcy in 2018, the ratio was above 1%, almost 1.5% as you can see there were particularly no owners/shareholders financing the debt-to-assets.
Ahern, D. (2021, October 6). What a good debt to asset ratio is; how to calculate it. Investing for Beginners 101. Retrieved March 16, 2022, from https://einvestingforbeginners.com/debt-to-asset-ratio-daah/
Kenton, W. (2022, February 8). Fixed asset turnover ratio. Investopedia. Retrieved March 16, 2022, from https://www.investopedia.com/terms/f/fixed-asset-turnover.asp
Zwolak, J. (2008). The impact of fixed assets on Polish Agricultural Production. Agricultural Economics (Zemedelská Ekonomika), 54(No. 1), 20-25. https://doi.org/10.17221/2722-agricecon
Herrero, A. V., & Malkin, E. (2017, January 17). Venezuela issues new bank notes because of hyperinflation. The New York Times. Retrieved March 16, 2022, from https://www.nytimes.com/2017/01/16/world/americas/nuevos-billetes-venezuela-new-banknotes.html?_r=0
Capozzi, C. (n.d.). The effect of inflation on rate of return. sapling. Retrieved March 16, 2022, from https://www.sapling.com/8082255/effect-inflation-rate-return