Ratio analysis

Definition

Ratio analysis involves evaluating financial statements to understand a company's operational efficiency, profitability, and solvency. It uses various ratios derived from financial data to assess performance in key areas like inventory management.

5 Must Know Facts For Your Next Test

1. The Inventory Turnover Ratio measures how often inventory is sold and replaced over a period.
2. Days Sales in Inventory (DSI) calculates the average number of days it takes to sell the entire inventory.
3. A high Inventory Turnover Ratio indicates efficient inventory management, while a low ratio may suggest overstocking or obsolescence.
4. DSI is inversely related to the Inventory Turnover Ratio; lower DSI indicates quicker sales of inventory.
5. Both ratios are crucial for assessing liquidity and ensuring that capital is not tied up unnecessarily in unsold goods.

Review Questions

• What does a high Inventory Turnover Ratio indicate about a company's inventory management?
• How is Days Sales in Inventory (DSI) calculated, and what does it signify?
• Why are both the Inventory Turnover Ratio and DSI important for assessing a company's liquidity?

Related terms

Inventory Turnover Ratio: A metric that shows how many times a company’s inventory is sold and replaced over a specific period.

Days Sales in Inventory (DSI): A measure of the average time required for a company to turn its inventory into sales.

Liquidity: The ability of a company to meet its short-term obligations using assets that can be quickly converted into cash.