43

.docx
School
University of the People **We aren't endorsed by this school
Course
BUS 4404
Subject
Accounting
Date
Nov 4, 2023
Pages
2
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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. Inventory Turnover: Inventory turnover is a financial metric that measures how efficiently a company manages its inventory. It is calculated by dividing the cost of goods sold (COGS) by the average inventory value. To compute inventory turnover, you first determine the average value of the inventory. This is typically done by adding the beginning inventory value to the ending inventory value and then dividing by two. The formula for inventory turnover is: Inventory Turnover = Cost of Goods Sold (COGS) / Average Inventory Value This metric indicates how many times a company's inventory is sold and replaced over a specific period, usually a year. A higher turnover implies that a company efficiently manages its inventory, while a lower turnover may suggest overstocking or slow-moving inventory. Use of Inventory Turnover: Inventory turnover is a crucial metric for businesses in industries where inventory management is a significant part of operations, such as retail and manufacturing. It helps companies: 1. Optimize Inventory Levels: It guides in maintaining an optimal level of inventory to meet customer demand without incurring excess carrying costs. 2. Identify Slow-Moving Items: A low turnover rate may indicate that some products are not selling well, prompting the company to adjust pricing, marketing, or sourcing strategies. 3. Improve Cash Flow: Efficient inventory turnover ensures that capital isn't tied up in unsold goods. Receivable Turnover: Receivable turnover is a financial metric that assesses how efficiently a company manages its accounts receivable. It is calculated by dividing the net credit sales by the average accounts receivable during a specific period. To compute receivable turnover, you determine the average value of accounts receivable, which is calculated by adding the beginning and ending accounts receivable and dividing by two. The formula for receivable turnover is:
Receivable Turnover = Net Credit Sales / Average Accounts Receivable This metric tells how many times a company collects its average accounts receivable during a period, usually a year. A higher turnover suggests that a company is efficient in collecting payments, while a lower turnover may indicate issues with collections. Use of Receivable Turnover: Receivable turnover is crucial for businesses that extend credit terms to customers, as it helps in: 1. Managing Cash Flow: It provides insights into the speed at which the company collects payments, aiding in cash flow management. 2. Identifying Credit Policies Effectiveness: It helps evaluate the effectiveness of credit policies. A low turnover might indicate lax credit standards, leading to potential bad debt. 3. Spotting Potential Collection Issues: A declining turnover rate may signal that customers are taking longer to pay, which could require adjustments in credit terms or collection strategies. Both inventory turnover and receivable turnover are valuable tools for assessing a company's operational efficiency and financial health. They are used by businesses, investors, and analysts to make informed decisions about inventory management and credit policies. Reference https://www.investopedia.com/terms/r/receivableturnoverratio.asp Receivables Turnover Ratio Defined: Formula, Importance, Examples, Limitations
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