Which statement about inventories is correct?
A)A reduction in inventories held would have no effect on the current ratio.
B)An increase in inventories would have no effect on the current ratio.
C)If a firm increases its sales while holding its inventories constant, then, other things held constant, its inventory turnover ratio will increase.
D)A reduction in the inventory turnover ratio will generally lead to an increase in the ROE.

Question

Quizplus · Accepted Answer

This statement is correct because inventory turnover ratio measures how efficiently a company is managing its inventory by relating cost of goods sold to the average inventory for a period. As sales increase and inventories are kept constant, the cost of goods sold will increase and the average inventory will remain the same, resulting in a higher inventory turnover ratio.

The other statements are incorrect:
A) A reduction in inventories held would decrease the current ratio because current assets (including inventories) are in the numerator, while current liabilities (the denominator) remain constant.
B) An increase in inventories would increase the current ratio because current assets would increase while current liabilities remain constant.
D) A reduction in inventory turnover ratio (i.e., a decrease in the efficiency of managing inventory) would generally lead to a decrease in ROE because lower sales or higher cost of goods sold would decrease the net income used in the ROE calculation.

Which Statement About Inventories Is Correct