CFA Practice Question

There are 90 practice questions for this study session.

CFA Practice Question

Which of the following would MOST LIKELY signal that a company's inventory is getting obsolete?
A. Low inventory turnover ratio
B. High inventory level
C. LIFO inventory method
Explanation: This ratio measures the number of times, on average, inventory is sold and replaced during the fiscal year. A low inventory turnover ratio is a signal of inefficiency, since inventory usually has a rate of return of zero. It also implies either poor sales or excess inventory. A low turnover rate can indicate poor liquidity, possible overstocking, and obsolescence, but it may also reflect a planned inventory buildup in the case of material shortages or in anticipation of rapidly rising prices.

User Contributed Comments 3

User Comment
Lt2201 Could somebody please explain this to me?
Isn't a high inventory level (relative to normal) a better indicator of obsolescence because it can indicate the company is struggling to sell off previous inventory (could also be stocking up for some reason), versus a low inventory turnover ratio that could just illustrate differences in product e.g. car dealers vs. supermarkets? If you were comparing a low inventory turnover relative to normal, shouldn't that also translate into a higher inventory balance relative to normal?
ascruggs92 High inventory may or may not be an indicator. For example, a company could have a much higher inventory level than the year before, but there could be other reasons beside inventory build up that led to that. Also, if a company has high inventory but also high inventory turnover, it does not indicate obsolescence.
NOBA also the inventory turnover ratio considers the sales or revenue and the inventory simultaneously. This allows the Analyst to compare the sales with inventory and not just the inventory in isolation. Sales/inventory (note a better measure is cost of good sold/average inventory for the period) to get average inventory- opening inventory + closing inventory/2. Bearing this in mind, the company would achieve a better efficiency if the denominator is small or low. This gives a high inventory turnover ratio while a high inventory results in low ratio. I think the point is in considering the inventory in isolation.
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