Analysts Maintain That Two of the Most Important Ratios Are

Question

Examlex · Accepted Answer

The Answer is a. A decrease in inventory turnover means that an average inventory is being held for a longer period of time before it is sold.
This may indicate:
- obsolete inventory (cannot be sold or only at deep discount - especially in this industry). This would obviously be a matter of concern. One might expect to see inventory write-downs next period.
- planned increase in purchasing in anticipation of increased demand for goods. This would be a good sign and will hopefully be followed by increased sales next period.
- less demand than expected in prior period. This would be a matter of concern. You might expect to see gross margins decrease next period if the company has to resort to sales to move inventory.
b. An increase in accounts receivable relative to sales can be due to the following reasons:
- More sales made on credit.
change in credit policy.
failure by employees to follow credit policy.
Some reason for concern but less worrisome than some other alternative explanations (see below)
- Customers are paying less quickly.
general recession
poorer quality merchandise
poorer job by credit department
All these would be reasons for concern. The first two might signal lower future sales in near term
- Change to more aggressive revenue recognition procedures - definitely a cause for concern. Why are they doing this? Have sales slowed down? Will the cash actually be forthcoming?
- Change in allowance for uncollectible accounts receivable. Is this because prior experience has been better than expected or is this an attempt to increase net income?
- Change in allowance for returns. Is this because prior experience has been better than expected or is this an attempt to increase net income?

Analysts Maintain That Two of the Most Important Ratios Are

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