… The lower the inventory days, the tighter your management of inventory and the better your cash position. If you look at inventory as “frozen cash,” then the faster you can get it out the door and collect the actual cash, the better off you will be. Moreover, how fast it flows matters a lot. Inventory flows through a company, and it can flow at a greater or lesser speed. (Excerpts from Financial Intelligence, Chapter 24 – Efficiency Ratios) In this example, inventory stayed in the system for an average of 60 days. (Financial folks tend to use 360 as the number of days in a year, simply because it’s a round number.) For example, if the income statement for year 2 shows COGS of $7,200, you would determine the inventory consumed per day as: To get a daily number, divide COGS by the number of days in a year. This tells us how much inventory is actually used each day. The denominator of DII is cost of goods sold (COGS) per day, found on the income statement. (Some companies use just the ending inventory number.) For example, if inventory at the end of year 1 is $1,400 and at the end of year 2 is $1,000:Īverage inventory for year 2 = ($1,400 + $1,000) / 2 You calculate average inventory by adding inventory at the end of the previous period to the inventory at the end of the current period, then dividing by 2. The ability to free inventory investment allows a company to invest in other ways. The goal is to meet customers’ needs and minimize inventory. On the other hand, too little inventory means a company may not be able to meet customer needs. Inventory is also subject to obsolescence and shrinkage. It also requires additional expenses such as costs for warehousing space, utilities, insurance, and staff to manage the inventory. It ties up cash that might be used for other purposes. On the balance sheet, inventory is an asset. Essentially, it measures the number of days inventory stays in the system. Days in Inventory or DII is also known as inventory days.
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