Question

500-800 words

Using words, not numbers, explain how an inventory turnover computation is performed, what it means, and what its use is. Please do the same for a receivable turnover computation.

Answer 1

What Is Inventory Turnover?

Inventory turnover is a ratio showing how many times a company has sold and replaced inventory during a given period. A company can then divide the days in the period by the inventory turnover formula to calculate the days it takes to sell the inventory on hand. Calculating inventory turnover can help businesses make better decisions on pricing, manufacturing, marketing and purchasing new inventory.

Inventory turnover computation :

Inventory Turnover = Sales / Average Inventory

where:

Average Inventory = (Beginning Inventory + Ending Inventory) / 2

Companies calculate inventory turnover by:

Calculating the average inventory, which is done by dividing the sum of beginning inventory and ending inventory by two.

Dividing sales by average inventory.

An alternative method includes using the cost of goods sold (COGS) instead of sales. Analysts divide COGS by average inventory instead of sales for greater accuracy in the inventory turnover calculation because sales include a markup over cost. Dividing sales by average inventory inflates inventory turnover. In both situations, average inventory is used to help remove seasonality effects.

Uses :

* Inventory turnover shows how many times a company has sold and replaced inventory during a given period.

* This helps businesses make better decisions on pricing, manufacturing, marketing, and purchasing new inventory.

* A low turnover implies weak sales and possibly excess inventory, while a high ratio implies either strong sales or insufficient inventory.

* It can help small retailers better manage decisions on how much inventory to buy, how to evaluate how inventory is performing, and assist with future inventory procurement.

Receivable turnover ratio :

What Is the Receivables Turnover Ratio?

The receivables turnover ratio is an accounting measure used to quantify a company's effectiveness in collecting its receivables or money owed by clients. The ratio shows how well a company uses and manages the credit it extends to customers and how quickly that short-term debt is collected or is paid. The receivables turnover ratio is also called the accounts receivable turnover ratio.

Receivables turnover computation :

Accounts Receivable Turnover Ratio =

Net Credit Sales / Average Accounts Receivable

(OR)

The formula for the accounts receivable turnover in days is as follows:

Receivable turnover in days = 365 / Receivable turnover ratio.

Uses :

* The accounts receivable turnover ratio is an accounting measure used to quantify a company's effectiveness in collecting its receivables or money owed by clients.

* A high receivables turnover ratio can indicate that a company’s collection of accounts receivable is efficient and that the company has a high proportion of quality customers that pay their debts quickly.

* A low receivables turnover ratio might be due to a company having a poor collection process, bad credit policies, or customers that are not financially viable or creditworthy.

* A company’s receivables turnover ratio should be monitored and tracked to determine if a trend or pattern is developing over time.