Question

Inventory turnover ratio $=$ Cost of goods sold $÷$ Cost of ______________ held during the period.

• A. Average inventory
• B. Minimum inventory
• C. Maximum inventory
• D. None of these

Answer 1

The correct option is A Average inventory

The turnover ratios exhibit the activity levels characterized by the capacity of the business to make more sales or turnover. The activity ratios express the number of times assets employed, or, for that matter, any constituent of assets, is turned into sales during an accounting period. Higher turnover ratio means better utilization of assets and signifies improved efficiency and profitability, and as such are known as efficiency ratios. Inventory turnover ratio determines the number of times stock is turned into sales during the accounting period under consideration. It expresses the relationship between the cost of goods sold and stock of goods. The formula for calculation is:

Inventory turnover ratio = Cost of Goods Sold/Average Stock

Where average stock refers to arithmetic average of opening and closing stock, and the cost of goods sold means sales less gross profit.

It studies the frequency of conversion of stock finished goods into sales. It is also a measure of liquidity. It determines how many times stock is purchased or replaced during a year. Low turnover of stock may be due to bad buying, obsolete stock, etc. and is a danger signal. High turnover is good but it must be interpreted as it may be due to buying in small lots or selling quickly at low margin to realize cash. It also throws light on utilization of stock of goods.