When analyzing the balance sheet, you want to look at the percentage of current assets inventory represents. If 70% of a company's current assets are tied up in inventory and the business does not have a relatively low turn rate (less than 30 days), it may be a signal that something is seriously wrong and an inventory write-down is unavoidable.
Inventory turnover = cost of goods sold / average inventory for the period.
Working capital is to calculate the difference between current assets and current liabilities.
Working capital = current assets - current liabilities
Usually speaking, working capital should be positive, and the higher, the better. However, there is an exception: negative working capital can be a good thing for high turn businesses thanks to the effect of leverage.
Companies that have high inventory turns and do business on a cash basis (such as a grocery store) need very little working capital. These types of businesses raise money every time they open their doors, then turn around and plow that money back into inventory to increase sales. Since cash is generated so quickly, managements can simply stockpile the proceeds from their daily sales for a short period of time if a financial crisis arises. Since cash can be raised so quickly, there is no need to have a large amount of working capital available.
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