A firm managing its raw materials efficiently may be able to manage with a smaller balance. This is reflected in a higher ______.
Answer & explanation
Correct answer: option 3
The correct answer is Option (3) → inventory turnover ratio
Option (1) debtors turnover ratio — Incorrect. This ratio shows how fast a firm collects money from customers who bought on credit. A better debtors turnover ratio reduces the amount tied up in receivables. It has to do with debtors, while raw materials are part of stock.
Option (2) interest coverage ratio — Incorrect. This ratio shows how many times the earnings before interest and taxes (EBIT) cover the interest a firm must pay. It is a factor in choosing the capital structure, used to judge how much debt a firm can carry.
Option (3) inventory turnover ratio — Correct. Raw materials are part of a firm’s inventory (stock). When a firm handles them well, it can work with a smaller stock. The stock then turns over more times in a year, so the inventory turnover ratio rises. Such efficiency lowers the working capital the firm needs.
Option (4) debt service coverage ratio — Incorrect. This ratio compares the cash profits of a firm with the cash it needs for interest, preference dividend and loan repayments. It shows the ability to meet debt payments, so it is used when deciding how much debt to raise.
NCERT (2026-27 Edition): “8. Operating Efficiency: Firms manage their operations with varied degrees of efficiency. For example, a firm managing its raw materials efficiently may be able to manage with a smaller balance. This is reflected in a higher inventory turnover ratio. Similarly, a better debtors turnover ratio may be achieved reducing the amount tied up in receivables. Better sales effort may reduce the average time for which finished goods inventory is held. Such efficiencies may reduce the level of raw materials, finished goods and debtors resulting in lower requirement of working capital.” “2. Interest Coverage Ratio (ICR): The interest coverage ratio refers to the number of times earnings before interest and taxes of a company covers the interest obligation. …” |