Formula to learn
Another ratio worth calculating is the inventory turnover period. This is another estimated figure, obtainable from published accounts, which indicates the average number of days that items of inventory are held for. As with the average receivable collection period, however, it is only an approximate estimated figure, but one which should be reliable enough for comparing changes year on year.
The inventory turnover period is calculated as:
lnventory x 365 days
Cost of sales
This is another measure of how vigorously a business is trading. A lengthening inventory turnover period from one year to the next indicates:
A slowdown in trading; or
A build-up in inventory levels, perhaps suggesting that the investment in inventories is becoming excessive.
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Generally the higher the inventory turnover the better, ie the lower the turnover period the better, but several aspects of inventory holding policy have to be balanced.
Lead times
Seasonal fluctuations in orders
Alternative uses of warehouse space
Bulk buying discounts
Likelihood of inventory perishing or becoming obsolete
Presumably if we add together the inventory turnover period and receivables collection period, this should give us an indication of how soon inventory is converted into cash. Both receivables collection period and inventory turnover period therefore give us a further indication of the company's liquidity.
Inventory turnover period: example
The estimated inventory turnover periods for a supermarket are as follows.
|
|
Company
|
Inventory
Cost of sales
|
period (days x 365)
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|
Previous year
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Supermarket
|
$15,554K
$254,571 К
|
22.3 days
|
$14,094K
$261,368K
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x 365 = 19.7 days
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