When comparing inventory turnover ratios, other things being equal (ceteris paribus): A. higher inventory tumover results from old or obsolete inventory increasing the inventory balance on the balance sheet. B. higher inventory turnover results from an increase in the selling price of the product. C. a lower inventory turnover is preferred in order to keep inventory costs low. D. a higher inventory turnover is preferred to improve liquidity.
The Correct Answer and Explanation is :
The correct answer is D. A higher inventory turnover is preferred to improve liquidity.
Explanation:
Inventory turnover refers to how often a company sells and replaces its inventory over a given period. It is a key financial metric that helps evaluate a company’s operational efficiency and how well it manages its inventory.
- A. Higher inventory turnover results from old or obsolete inventory increasing the inventory balance on the balance sheet: This is incorrect. Obsolete or old inventory typically leads to lower turnover ratios because these items are not selling as quickly. The turnover ratio is positively correlated with how quickly inventory moves through the business, and holding on to old or obsolete inventory hampers this process.
- B. Higher inventory turnover results from an increase in the selling price of the product: This is not accurate. While an increase in the selling price could increase revenue, it does not directly affect the inventory turnover ratio, which is focused on the volume of sales and inventory replacement. It is possible to have high turnover with low prices if sales volume is high, and vice versa.
- C. A lower inventory turnover is preferred in order to keep inventory costs low: This is incorrect. A lower inventory turnover generally indicates that inventory is not being sold or replenished quickly, which ties up capital and increases storage costs. Companies aim to keep their turnover ratio high to minimize such costs and improve cash flow.
- D. A higher inventory turnover is preferred to improve liquidity: This is correct. A higher inventory turnover indicates that inventory is sold and replaced quickly, freeing up cash that can be used for other purposes, such as reinvestment in the business or paying down debt. High inventory turnover helps improve liquidity by ensuring that capital is not tied up in unsold goods.
In conclusion, a higher inventory turnover is a sign of efficient inventory management and is generally preferred because it leads to better liquidity and a more streamlined business operation.
I’ll generate a visual representation of this for you.
Here is a visual chart comparing different inventory turnover scenarios. It illustrates how high inventory turnover leads to improved liquidity and how low turnover can result in higher costs and capital being tied up. Let me know if you need further clarification or modifications!
