Mathematics · Financial Ratio Analysis
A credit officer observes that a company's Inventory Turnover Ratio has significantly decreased. The company uses the First-In-First-Out (FIFO) method for inventory valuation during a period of persistent inflation. Which of the following interpretations is most accurate?
Verified Solution4 OptionsUpdated: October 2026👁️1 View
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- 1The Inventory Turnover Ratio is independent of the valuation method used, meaning the decline is purely due to a drop in the Cost of Goods Sold.
- 2The declining ratio suggests potential overstocking or obsolescence of inventory, and the FIFO method under inflation may be inflating the denominator, contributing to a lower ratio.✓
- 3The use of FIFO during inflation results in a lower valuation of closing stock, which artificially inflates the Inventory Turnover Ratio.
- 4The decrease in the ratio indicates that the company is selling its inventory faster than the previous year, leading to higher cash flow.
Correct answer
The declining ratio suggests potential overstocking or obsolescence of inventory, and the FIFO method under inflation may be inflating the denominator, contributing to a lower ratio.
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