10.CHAPTER 4: RATIO ANALYSIS : ACTIVITY RATIOS : INVENTORY RATIO, Assignment # 7 with Answers

April 22, 2020

HELLO GENTLEMAN!

Learning Outcomes:

Students will be able to know:
The meaning of the Activity Ratios
Objectives of the Activity Ratios

Classification or Types of Activity Ratios
Inventory turnover ratio : formula and significance

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INTRODUCTION TO ACTIVITY RATIOS:

Activity (or Turnover ratio )Ratio

These ratios indicate the speed at which activities of the business are being performed. The activity ratios express the number of times assets employed or any constituent of assets, is turned into revenue from operations during an accounting period.

Higher turnover ratio means better utilisation of assets and signifies improved efficiency and profitability, and as such are known as efficiency ratios.

The important activity ratio calculated under this category are :

1.Inventory turnover ratio
2. Trade receivables turnover ratio
3. Trade payables turnover ratio
4. Working capital turnover ratio

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INVENTORY TURNOVER RATIO

Inventory Turnover Ratio

It determines the number of times inventory is converted into revenue from operations during the accounting period. It expresses the relationship between cost of revenue from operations and average inventory.

lnventory turnover ratio = cost of revenue from operation divided by average inventory

where,

average inventory = opening inventory + closing inventory divided by 2

Cost of revenue from operations = revenue from operations - gross profit (or + gross loss)

Alternatively,
cost of revenue from operations = opening inventory + net purchases + direct expenses - closing inventory

Significance ..it study the frequency of conversion of inventory of finished goods into revenue from operations. It is also a measure of liquidity. It determines how many times inventory is purchased or replaced during a year.

Low inventory turnover ratio may be due to bad buying, obsolete inventory, etc., and is a danger signal.

High inventory turnover ratio is good but it must be carefully interpreted as it may be due to buying in small lots or selling quickly at low margin to realise cash.

Thus, it throws light on utilisation of inventory of goods.

Ques.1 ( EXAMPLE)

1. From the following information related to a company, calculate inventory turnover ratio ..
opening inventory 20,000
closing inventory 22,000
purchases 80000
wages 9000
carriage outwards 2000
return outwards 1000
revenue from operations 80,000 carriage inwards 4000
rent 5000

Ans.

inventory turnover ratio = cost of revenue from operations /average inventory

cost of revenue from operation = opening inventory + net purchases (purchases - return outwards) + direct expenses( wages + carriage inwards) - closing inventory

= 20000 + (80000 - 1000 )+ (9000 + 4000) - 22000
= 90000
average inventory = opening inventory + closing inventory/ 2
= 20000 + 22000/2
= 21000
therefore, inventory turnover ratio = 90000/ 21000
= 4.29 times

ASSIGNMENT # 7

Ques. 1

From the following information related to a company, calculate inventory turnover ratio ..
opening inventory 62000
purchases 420000
revenue from operation 600000 gross profit is 33 1/ 3% on cost.

(Ans. 9.57 times)

Ques. 2

A trader carries on average inventory 80000. His inventory turnover ratio is 12 times. Find out his gross profit if he sells at a margin of 20% on selling price.

(Ans. 240000)

Ques. 3

Calculate inventory turnover ratio.. revenue from operations 1000000
Average inventory 200000
gross loss ratio 20%

Ans.6 times

ANSWERS TO ASSIGNMENT # 7

Ans.1
gross profit = 331/ 3% on cost.
revenue from operation = cost of revenue from operations + gross profit
= 6 lakh = X + 1 /3 x
=6 lakh = 4/3 X
=X = 6 lakh x 3/ 4
therefore, cost of revenue from operations = 450000
now, cost of revenue from operations = opening inventory +purchases -closing inventory
450000 = 62000 + 420000 - closing inventory
closing inventory = 482000 - 450000
average inventory = 62000+ 32000/ 2
This, inventory turnover ratio = 450000 / 47000

Ans.2

Inventory turnover ratio= cost of revenue from operation /average inventory
12 = cost of revenue from operation/ 80000
suppose revenue from operation = X
revenue from operations = cost of revenue from operations + gross profit
X = 960000 + 20%(1/5) of X
X= 960000 + 1/5 X
= X - 1 / 5 X = 960000
=4 /5 X= 960000
= X= 960000 x 5/ 4
This, revenue from operation = 12 lakh
therefore gross profit = 20% of 1200000 = 240000

Ans.3
Inventory turnover ratio = cost of revenue from operation/ average inventory
cost of revenue from operation = revenue from operation + gross loss
= 10 lakh + 20% of 10 lakh
= 10 lakh + 2 lakh = 12 lakh
average inventory = 2 lakh
therefore,

12 lakh / 2 lakh = 6 times