Difference between revisions of "Calculate Days in Inventory"

#Learn the definition of inventory turnover ratio.  Inventory turnover means how many times a business sells and replaces its inventory in a given period of time.  A low turnover rate  indicates unproductive assets and lower profits. The company is holding on to too much excess inventory because it is not selling fast enough. A high turnover rate may be an indication of lost sales as products may be out of stock when a customer wants to buy them. <ref name="rf1"> http://www.investopedia.com/terms/i/inventoryturnover.asp</ref>

#*Inventory can also be calculated by dividing sales by inventory.<ref name="rf2">http://www.investopedia.com/ask/answers/070914/how-do-i-calculate-inventory-turnover-ratio.asp</ref>   

#Determine the cost of goods sold.  The cost of goods sold is the direct expense associated with providing a service or producing a product.  For the service industry, cost of goods sold includes labor expenses, including wages, taxes and benefits.  In retail or wholesale, the cost of goods sold is comprised of merchandise that was purchased from a manufacturer, plus the expenses associated with acquiring, storing, and displaying inventory items.<ref name="rf3">http://www.accountingtools.com/definition-cost-of-goods-sold</ref>

#Determine the average inventory.  Average inventory is the median value of inventory within an accounting period.<ref name="rf4">http://www.investopedia.com/terms/a/average-inventory.asp</ref>  The value of inventory may change significantly within an accounting period.  Therefore, it makes sense to calculate the average inventory when comparing inventory to total sales or cost of goods sold.  This calculation eliminates confusion from spikes in the inventory level.<ref name="rf5">http://www.accountingtools.com/average-inventory-calculation</ref>

#Learn the meaning of days in inventory.  Once you know the inventory turnover ratio, you can use it to calculate the days in inventory.  Days in inventory is the total number of days a company takes to sell its average inventory.  It also determines the number of days for which the current average inventory will be sufficient.  Companies use this metric to evaluate their efficiency in using their inventory.<ref name="rf6">http://accountingexplained.com/financial/ratios/days-inventory-on-hand</ref>

#Apply an alternate formula.  If you have not calculated the inventory turnover ratio, you could simply use the cost of goods sold and the average inventory figures.  You would divide the average inventory by the COGS.  Then you would multiply that number by the number of days in the accounting period.<ref name="rf7"> http://www.investopedia.com/ask/answers/070914/how-do-i-calculate-inventory-turnover-ratio.asp</ref>

#Examine the cash conversion cycle.  The cash conversion cycle measures the number of days it takes a company to convert its resources into cash flow.<ref name="rf8"> http://www.investopedia.com/terms/c/cashconversioncycle.asp</ref>  Days in inventory is the first of three parts for this calculation.  The second is the days sales outstanding, which is the number of days it takes the company to collect on accounts receivable.  The third part is the days payable outstanding, which states how many days it takes the company to pay its accounts payable.<ref name="rf9"> http://www.investopedia.com/terms/d/dsi.asp</ref>

#*The cash conversion cycle follows cash as it is first turned into inventory and accounts payable, then into sales and accounts receivable, and finally back into cash again.<ref name="rf10"> http://www.investopedia.com/articles/06/cashconversioncycle.asp</ref>

#Evaluate inventory effectiveness.  The number of days in inventory expresses how long a company holds on to its inventory.  This clarifies how long a company’s cash is tied up in its inventory.  The longer a company holds on to its inventory, the more chances it has of losing money on that investment.  Items in inventory can become outdated or they can expire.  Also, prices can fall, which devalues the inventory.<ref name="rf9" />

#Compare your company’s days in inventory with other businesses in the same industry.  The number of days in inventory makes more sense as a measure of effectiveness if you compare it with that of other businesses in the same industry.  Different kinds of businesses sell their inventory at different rates.  Retailers who sell perishable items have a smaller number of days in inventory than a company that sells cars or furniture.  Therefore, compare your days in inventory with other businesses in the same industry to determine if you are selling your inventory efficiently.<ref name="rf9" />