Q9RQ - Horngren'S Financial And Managerial Accounting

Question

Briefly describe the ratios that can be used to evaluate a company’s ability to sell merchandise inventory and collect receivables.

Step-by-Step Solution

Answer

Inventory turnover ratio, 

Gross Profit ratio, 

Accounts Receivable ratio etc.

Step 1: Meaning of Ratio

The ratio indicates the association between the two numbers or quantities and shows how one element of the ratio relates to the other.

Step 2: Explanation of some ratios use by the companies

1. The inventory turnover ratio indicates the average inventory sold by how many times a period.

Formula:

$\text{Inventory} \text{turnover} \text{ratio}=\frac{\text{Cost} \text{of} \text{goods} \text{sold}}{\text{Average} \text{merchandise} \text{inventory}}$

  2.Days' sales in inventorytell the average number of day’s inventory is held before converting it into sales by the company or organization. 

Formula:

$\text{Days'} \text{sales} \text{in} \text{inventory}=\frac{365}{\text{Inventory} \text{turnover}}$

3. Gross profit percentage measures the percentage of gross profit earned by the company on its net sales.

Formula:

$\text{Gross} \text{profit} \text{percentage}=\frac{\text{Gross} \text{profit}}{\text{Net} \text{sales}}$

4. Accounts receivable turnover shows how many times receivables are collected by the company over the year.

         Formula:

$\text{Average} \text{receivables} \text{turnover} \text{ratio}=\frac{\text{Net} \text{credit} \text{sales}}{\text{Average} \text{net} \text{accounts} \text{receivable}}$

5. The total days of collection of receivables show the days to collect receivables, also known as Day's Accounts Receivable collection Ratio.

          Formula:

$\text{Days'} \text{accounts} \text{receivable} \text{collection} \text{ratio}=\frac{365}{\text{Accounts} \text{receivable} \text{turnover}}$