The company uses the inventory turnover ratio to determine whether inventory is becoming obsolete. This is an example of what type of information?
Answer a. Budget vs. actual analysis. b. A key performance indicator. c. Deficiency in operation. d. A key risk indicator.
The correct answer and explanation is:
Correct Answer: b. A key performance indicator.
The use of the inventory turnover ratio to monitor whether inventory is becoming obsolete is an example of a key performance indicator (KPI). KPIs are measurable values that demonstrate how effectively a company is achieving key business objectives. In this case, the inventory turnover ratio reflects how often a company sells and replaces its inventory over a specific period. A high turnover rate usually indicates strong sales, while a low rate might signal weak sales or excess inventory, which could become obsolete.
Monitoring inventory turnover helps the company assess the efficiency of its inventory management practices. If products are not moving quickly enough, it might mean the company is holding onto outdated or slow-selling items, which could lead to financial losses. Conversely, a high turnover rate might indicate effective inventory management and good product demand.
This information helps managers make informed decisions about purchasing, production planning, and sales strategies. For example, if turnover is decreasing, management may investigate the cause and take corrective action such as reducing order sizes, discounting old stock, or updating product lines.
This differs from the other options provided. “Budget vs. actual analysis” involves comparing planned financial outcomes with actual results, not necessarily tied to operational performance indicators. “Deficiency in operation” would imply a specific failure in process, not the monitoring of ongoing performance. “Key risk indicators” are metrics that show potential future risks, such as rising default rates or compliance issues, rather than current operational performance.
Therefore, using the inventory turnover ratio to evaluate potential inventory obsolescence is clearly aligned with tracking business performance, making it a key performance indicator.