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Inventory Turnover (Days)

Inventory Turnover (Days) (Days Inventory Outstanding) – an activity ratio measuring the efficiency of the company's inventories management. It indicates how many days the firm averagely needs to turn its inventory into sales. The ratio can be computed by multiplying the company's average inventories by the number of days in the year, and dividing the result by the cost of goods sold.

The decline of the inventory turnover (days) value during the year is a positive trend for the company. It means that less funds are being distracted to form the inventories. To estimate the efficiency of the company's efforts in this area more precisely, it is reasonable to compare the value of this ratio with the major competitors. Normative values of the inventory turnover (days) for different industries look as follows:

Indicator Agricultural production Oil and Gas Extraction Electric Power Generation, Transmission and Distribution Construction of Buildings Miscellaneous Store Retailers Religious, Grantmaking, Civic and Professional Organizations
Accounts Receivable Turnover (Times) =<76,6 =<11,29 =<16,51 =<67,92 =<76,6 =<8,8

Source: Almanac of Business and Industrial Financial Ratios

Overall, the faster is the period of one turn of the company's average inventories, the more efficient its inventories management is. Should be remembered that the ratio value happens to be too low. In this case, the production or sales process can be paralyzed. That's why the inventories management policy must take into account seasonal fluctuations, changes in consumers tastes, peculiarities of the industry and production process, delivery delays, etc.

Resolving the problems with the inventory turnover (days) exceeding the normative range:

In case the inventory turnover value exceeds the normative range it is necessary to optimize the inventories structure. To do this the ABC-analysis, XYZ-analysis and other methods can be applied. Decreasing the inventories volume would allow shortening the necessary amount of financial resources. This would reduce the expenses or increase the company's income if the money is invested in the firm's activity intensification.

Formula(s):

Inventory Turnover (Days) = Average Inventory ÷ (Cost of Goods Sold ÷ 360)

Inventory Turnover (Days) = 360 ÷ Inventory turnover (Times)

Should be mentioned that the value of the inventory turnover (days) can fluctuate during the year (for instance, due to the seasonality factor). The economic activity of the company slows down at the end of the year, which means that the inventories, unfinished goods, finished goods stock will be lower. Because of this, the computed period of one turn of the average inventories will be higher than it actually is. And vice versa, if the company's financial report is reflecting the data from the periods of the company's economic activity peaks, the turnover calculated will be higher, and the period of one turn will be lower than they actually are.

Example:

Company A

Balance Sheet

Current assets

$

as of

12/31/YEAR1

$

as of

12/31/YEAR2

$

as of

12/31/YEAR3

Inventory 310 314 316

 

Company A

Income Statement

 

$

as of

12/31/YEAR2

$

as of

12/31/YEAR3

Cost of Goods Sold 3351 3854

Inventory Turnover (Days) (Year 1) = ((314 + 310) ÷ 2) ÷ (3351 ÷ 360) = 33,5

Inventory Turnover (Days) (Year 2) = ((316 + 314) ÷ 2) ÷ (3854 ÷ 360) = 29,4

In year 1 company averagely needed 33,5 days to turn its inventory into sales. In year 2 the company has reduced this value to to 29,4, indicating that a company has been intensifying its sales.

Conclusion:

The inventory turnover is an important indicator of the firm's efficiency. The company's management is interested in keeping its inventory turnover high because this would reflect that the firm is not purchasing too much inventories and at the same time is not storing the excessive inventories, which are slowly convertible to finished goods.