A little light kept going on in the back of W's mind, as he listened to the Inquisitor ramble on in front of the Jury. W wasn't sure what that light was, but he felt that he was on to something. Directly below where he had been reading about receivable turnover was some information about inventory turnover. The Fool's sheet first displayed a small table:

                       QuickCo              SlowCo

Sales                $150,000,000      $250,000,000
Cost of goods sold   $ 90,000,000      $150,000,000
Accounts receivable  $ 25,000,000      $100,000,000
Inventory            $ 30,000,000      $200,000,000

QuickCo's inventory turnover is: $90,000,000/$30,000,000. Days sales in inventory for QuickCo are about 122, either 365/3, or

                       $30,000,000
                     ----------------
                     $90,000,000/365

The diagram was accompanied by a small side bar in which W read:

"Inventory turnover is similar to accounts receivable turnover, but is based on cost of goods sold, not on sales. The reason is that basing inventory turnover on sales overstates physical turnover. Additionally, selling prices would affect turnover based on sales so that a company with a higher gross margin would appear to be turning its inventory faster, but might not in fact be doing so.

"The important concern is how long it takes the company to sell its inventory, how liquid the inventory is."

W threw the Fool's sheet aside for a moment and looked at Rodeo Semiconductor's financials. Immediately thereafter, W interrupted the Inquisitor, who had been talking the entire time, "Excuse me, but you are forgetting that Rodeo was indeed in dire trouble! Their inventory turned over barely once a year!!" Then, in a softer voice, he challenged the Inquisitor, "Surely the significance of such numbers is not lost on you?"

***What would cause a company to have a low inventory turnover?***

1) A lot of obsolete, or otherwise slow-moving goods.

2) Recently increased selling prices in response to high demand.

3) Customers are taking more time to pay for their purchases.

4) All of the above.

Liquidity information provided by Joe Louderback.

The answer is 1) A lot of obsolete, or otherwise slow-moving goods.

Occasionally consulting the Fool's sheet, W expounded to the jury, "The more inventory that is not selling, the lower the turnover. A low, and decreasing, turnover is a serious sign because it indicates slowing sales of many products. Inventory turnover declines when inventory rises faster than sales (physical sales, as measured by cost of goods sold). We expect inventory to rise as sales rise. Companies today try to minimize inventory because of the costs associated with it."

Just as the Inquisitor began to agree, but twist what W had said, a loudly buzzing alarm clock hurtled him into reality. Eyes wide open, Alex Wright stared up from his pillow. "God, that was a weird dream," he said. On the floor next to his bed was a copy of The Motley Fool Investment Guide and The Trial, by Franz Kafka. "Tomorrow night," he continued, "I'll have to remember: never mix Kafka and Foolery."

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