Question

I want to know the relationship between inventory turnover ratio and allowance for obsolescence in inventory.

Basically, I am analyzing a company's financial statement, and this company is in bad position, high leverage (borrowed 1B last year), one of the sector filled chapter 11, and there are many other bad signs. Therefore, I thought the inventory turnover ratio in 2016 would be better than 2017's, however, it came out to be 2017's inventory turnover ratio was little bit higher than 2016's.

In this company's 10-k report, it says that "allowance for obsolescence in inventory from 2016 to 2017, which was 221.70%." is this the reason for higher inventory turnover ratio in 2016 than 2017? Or is it just irrelevant to the inventory turnover ratio? Can someone explain this?

Answer 1

Yes there is a relationship between inventory turnover ratio and allowance for obsolescence in inventory

Inventory turnover is used for measurement over a period. This is useful to know the business has an excess investment in stock than what is actually required for sales, which leads to unexpected poor inventory planning.

Inventory turnover ratio = Cost of goods sold / Inventory

The impact of inventory turnover will be based on the following items:

1. If the inventory is maintained as per seasonal requirement

2. If the inventory become obsolete i.e out of date

3. obtaining the bulk of goods for obtaining huge discounts which leads to high investment in inventory

The inventory turnover ratio gets effected with increase in obsolescence of stock if the obsolete stock was written off the ratio will change rspectively

The same was happened even in your company report also due to increase in obsolescence of stock, inventory turnover ratio is also high