Days of Inventory Ratio and QuickBooks 2014

In QuickBooks, the days of inventory ratio resembles the inventory turnover financial ratio; it estimates how many days of inventory a firm is storing. The ratio uses the following formula:

average inventory/(annual cost of goods sold/365)

For example, the simple balance sheet shows inventory equal to \$25,000. Assume that this also equals the average inventory that the firm carries.

A Simple Balance Sheet
Assets
Cash \$25,000
Inventory 25,000
Current assets \$50,000
Fixed assets (net) 270,000
Total assets \$320,000
Liabilities
Accounts payable \$20,000
Loan payable 100,000
Owner’s equity
S. Nelson, capital 200,000
Total liabilities and owner’s equity \$320,000

In order to calculate the daily sales, you take the cost of goods sold number reported in the annual income statement shown and divide it by 365 (the number of days in a year).

 Sales revenue \$150,000 Less: Cost of goods sold 30,000 Gross margin \$120,000 Rent 5,000 Wages 50,000 Supplies 5,000 Total operating expenses 60,000 Operating income 60,000 Interest expense (10,000) Net income \$50,000

Putting these numbers together in the formula just introduced, the math looks like this:

\$25,000/(\$30,000/365)

This formula returns the value 304 (roughly). This value means that this firm is carrying roughly 304 days of inventory. Stated another way, this firm would require 304 days of sales to sell its entire inventory.

As is the case with the inventory turnover ratio, you don’t see generalized rules about what is an acceptable number for days of inventory. The general rule is that you turn around your inventory just as quickly as your competitor does.

The case of Dell Computer is so instructive — even if scary — to most. Dell sells out its inventory in a few days. Dell’s competitors were taking months to sell out their inventory. In an industry in which inventory was quickly becoming obsolete and was very expensive to start with, think of the competitive disadvantage that Dell’s competitors suffered by having to carry inventory for months longer than Dell did.

Is it any wonder that many of Dell’s competitors got into trouble? The lesson of Dell applies to many folks who run or advise businesses that carry inventory. Inventory turnover and days of inventory ratios need to be watched carefully and compared with those of other firms of the same size in the same industry.