Chartered Financial Analyst (CFA) Level 1 Practice Exam

Which ratio would likely indicate better management of inventory?

1. Days of Inventory on hand

2. Receivables Turnover

3. Number of Days Payables

4. Fixed Assets Turnover

The correct answer is: Days of Inventory on hand

The ratio that is most indicative of better management of inventory is the Days of Inventory on Hand. This metric measures how many days it takes, on average, for a company to sell its entire inventory during a specific period. A lower number of days suggests that a company is efficiently managing its inventory, reducing the risk of obsolescence, and turning over stock more quickly, which is generally a sign of good inventory management practices. In contrast, other ratios, while relevant to overall operational efficiency, do not focus specifically on inventory management. For example, Receivables Turnover measures how effectively a firm collects its receivables and could reflect management's efficiency in credit control and cash flow, but it does not provide direct insights into inventory levels. Similarly, the Number of Days Payables assesses how long a company takes to pay its suppliers, which relates more to cash flow management than to inventory practices. Fixed Assets Turnover evaluates how well a company utilizes its fixed assets to generate sales, but again, it does not pertain directly to inventory management. Thus, the Days of Inventory on Hand is the optimal ratio among the options provided for assessing and indicating effective inventory management within a company.