Financial Ratios (Inventory Management)

Question 1

What is inventory?

Answer 1

Goods for resale purposes

Question 2

State the formula for inventory turnover rate.

Answer 2

cost of sales / average inventory

Question 3

State the unit for inventory turnover rate.

Answer 3

times

Question 4

Calculate the inventory turnover rate if cost of sales was $40 000 and opening inventory was $5 000; closing inventory was $6 000.

Answer 4

Average inventory = [5000+6000]/2
= $5 500
Inventory turnover rate = cost of sales / ave inventory
= 40 000 / 5 500 = 7.27 times

Question 5

What does inventory turnover rate of 8 times mean?

Answer 5

It means business replenishes its inventory 8 times in a year. This means business restock about 1.5 months or the inventory is sold in about 1.5 months’ time.

Question 6

If inventory turnover rate is 10 times and cost of sales is $50 000. What is average inventory?

Answer 6

Ave inventory = cost of sales / inventory turnover rate
= 50 000 / 10
= $5 000.

Question 7

If inventory turnover rate is 12 times, cost of sales is $48 000 and opening inventory is $5000. What is closing inventory?

Answer 7

Ave inventory = cost of sales / inventory turnover rate
= 48 000/12 = $4 000
Closing inventory = [Ave inventory X 2] - opening inventory
= 4 000 X 2 - $5 000 = $3 000

Question 8

What is an ideal inventory turnover rate?

Answer 8

Nil - every industry has its own acceptable norm.

For freshness, a high rate is better.

Question 9

How can a business increase its inventory turnover rate?

Answer 9

1. Buy inventory at a smaller quantity

2. Increase sales through promotion

Question 10

How does a low inventory turnover rate affect liquidity?

Answer 10

A low inventory turnover rate is likely due to high inventory held. If there is high inventory, quick ratio may be low.