Why is reduction in the number of days’ sales in inventory a good management policy? A. Reduction in the number of days’ sales in inventory lowers both your cost of financing the inventory purchases and your cost of storing the inventory. B. Reduction in the number of days’ sales in inventory is usually an effective way of lowering depreciation expense. C. Reduction in the number of days’ sales in inventory is directly associated with both an increase in P/E Ratio and an increase in book value per share. D. Reduction in the number of days’ sales in inventory reduces a company’s bad debt expense as well as the company’s Allowance for Bad Debts as a percentage of ending Accounts Receivable.

A. Reduction in the number of days’ sales in inventory lowers both your cost of financing the inventory purchases and your cost of storing the inventory.

This is considered good management policy for a few reasons. Firstly, less time that goods sit in inventory means a company has less money tied up in its stock. This means the company can have more cash available for other purposes, such as investing in growth opportunities or paying down debt. Secondly, carrying less inventory can also decrease storage costs, including warehousing, insurance, and potential spoilage or obsolescence costs. Additionally, it indicates that a company is more efficient in managing its inventory, which can lead to an improved cash flow situation.

Extra: Let's dive deeper into inventory management concepts:

1. Days' Sales in Inventory (DSI) explains how long it takes for a company to turn its inventory into sales. A lower DSI is generally a sign of efficiency, as it indicates that a company can quickly sell its products.

2. Inventory Carrying Costs refer to the total costs associated with holding and storing unsold goods. These costs include financing costs (interest paid on the money used to purchase inventory), storage costs (rent, utilities, security), insurance, and costs related to items becoming obsolete or spoiled.

3. Cash Flow Management is crucial for business operations, and efficient inventory management plays a key role in it. If inventory is sold faster, this means cash tied up in inventory is released quicker, ready to be used for other business needs or to respond to market opportunities.

4. Depreciation Expense (mentioned in option B) is less directly related to inventory management and more related to the wear and tear on long-term assets like equipment and buildings over time. Thus, while inventory turnover does not usually affect depreciation expenses, it is an important concept in asset management.

5. P/E Ratio and Book Value Per Share (mentioned in option C) reflect a company's valuation metrics but are not directly influenced by inventory turnover. They are affected by profit margins, growth prospects, and how the market views the company's future performance.

6. Bad Debt Expense (mentioned in option D) is associated with the inability to collect on sales made on credit. While managing inventory more efficiently can help a business be more financially stable, it doesn't directly affect bad debt expense. The Allowance for Bad Debts relates to accounts receivable, not inventory.

Good inventory management can lead to a variety of positive financial outcomes for a company, but its impact on specific accounting line items can vary. It's important for students to understand the different areas of financial management and how they interrelate.