Question

Establish the relationship between a high inventory turnover ratio in the automobile industry and financial well-being of companies in that industry.

Answer 1

In the automobile industry, inventory accounts for a significant part of the business. Inventory turnover ratio is calculated by dividing the cost of goods sold for a period by the average inventory for that period. Inventory turnover is a measure of how efficiently a company can control it's merchandise, so it is important to have a high turn. This measurement also shows investors how liquid a company's inventory is. This measurement shows how easily a company can turn it's inventory into cash. Creditors are particularly interested in this because inventory is often put up as collateral for loans. Banks want to know that this inventory will be easy to sell.

The inventory turnover ratio is an important evaluation metric specifically applied within the auto industry to auto dealerships. It is usually a warning sign for auto sales if auto dealerships begin carrying substantially more than about 60 days worth of inventory on their lots. It is good measure of how efficiently a company manages ordering and inventory, but more importantly for dealerships, it is an indication of how rapidly they are selling the existing inventory of cars on their lot.

The high inventory turnover ratio in automobile industry means the company is able to sell its cars and generate liquidity and thus ensuring financial well being of the company. Thus there is direct relationship between high turnover ratio in the automobile industry and the financial well being of the companies in that industry.