For example, if the inventory is increased in anticipation of a market shortage or a rapid price increase. There are also some exceptional cases where a low inventory ratio is preferred. These are signs which do not bode well for a companys overall performance. A low inventory ratio may suggest overstocking, product deficiencies, or poor management of inventory. Studies suggest that stocks with higher inventory ratios tend to outperform industry averages. It informs the investor of how effective a company is in managing its inventory compared with its competitors. It is important to compare the DII of one company to another in the same industry.įor example, the companies that sell food items or products that expire quickly have low DII while those companies which sell slow-moving products or non-perishable products tend to have a high DII.īoth these metrics, days in inventory and inventory turnover ratio, help an investor in making investment decisions. The DII is another measure to check the effectiveness of inventory management.Ĭalculating the number of days a company holds on to an inventory before it is sold, the length of time the companys cash is tied up in inventory can be calculated. The DII is the first stage in the cash conversion cycle, which represents the conversion of raw materials into cash. It is important to note that the average DII changes from one industry to another.ĭII is also referred to as days inventory outstanding (DIO), days sales of inventory (DSI), or simply days inventory. It is always preferable if the DII is low because the goods produced are being cleared from the companys stock at a high rate. DII has its formula and is used by accountants and bookkeepers across the globe. It gives an idea to the investors about how long it will take the company to convert the inventory into sales. The days in inventory (DII) is a financial measure of a companys performance. Dividing the year into different quarters and calculating the average inventory of the 4 quarters. The period in calculating the turnover ratio is usually taken as a year. This will give more attention to the cost of materials. Inventory turnover will be more refined if the labor cost and other overheads are removed from the cost of goods. The cost of goods is reported on the income statement.
Other factory overheads can also be included. It can include the cost of raw materials and labor costs required for making the goods. The cost of goods sold is the production cost of goods and services that the company produces. Here average inventory is used because companies may have higher or lower levels of inventory at different times of the year.įor example, some companies would likely have a higher inventory before a certain holiday period and lower inventory levels after the holiday.Īverage inventory is usually calculated by adding the inventory at the start and inventory at the end of a given period and dividing this by two. Inventory Turnover Ratio = Cost of Goods Sold / Average Inventory To calculate this ratio cost of goods sold is divided by the average inventory for the same period. It details how much inventory is sold within a period, commonly a year. It shows how successfully a company is managing its inventory. The inventory turnover formula is also known as the inventory turnover ratio or the stock turnover ratio.
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