Question

How does inventory turnover provide information about a company’s short-term liquidity?

Short answer

Inventory turnover indicates liquidity by estimating the number of times inventories are sold by the business. The higher turnover ratio indicates that the business is required to invest a small amount in the inventory, which finally results in higher liquidity.

Step-by-step solution

Explanation of Liquidity

Liquidity indicates the availability of funds to settle the short-term cash obligations of the business.

Explanation of inventory turnover ratio

The inventory turnover ratio is one of the financial ratios which measures the liquidity of the entity. It is calculated by dividing the cost of goods sold by the average inventory. Higher inventory turnover indicates the goods are sold quickly by the business entity, which helps the business in receiving funds to satisfy obligations.