Introduction to Accounting Preparing for a User s Perspective

Introduction to Accounting Preparing for a User’s Perspective Compute and understand the Inventory Turnover ratio By Kevin C. Kimball, CPA with support from Debits and Credits Trainer www. canvas. net Free Jan. 2014 Available on the Google Play Store

Inventory turnover ratio indicates how: How can we get this inventory sold more quickly? Effective Let’s buy $70 K of inventory. Purchase from suppliers Inventory Sell to customers Cost of Goods Sold Management Efficient

10 days 20 days 30 days 60 days Go sour. Ughhh! Pet rock Go out of style Become Obsolete If you hold Inventory too long it can: Oversupply

Christmas Day (December 25 th) December 24 th $50 each December 26 th FREE, Please recycle

Inventory turnover Days sales of inventory 24 times per year Low gross margins 4 times per year High gross margins

Raw materials Work-inprocess Finished goods $100 Inventory purchase Day 1 $100 Inventory sale – Cost of Goods Sold < ----- Within One Month ------ > If sell average inventory balance every month, Day 30 inventory will “turnover” about 12 times per year

If we stop buying today, how long is it going to take us to get rid of this stuff? Inventory turnover Days sales of inventory

Yellow Banana Co. Inventory turnover = 60 $0 cash inflow? = sell in 6. 08 days (365 days / 60 Inv turnover) Sell before turn brown Sell at full price $. 50 lb Lower inventory carrying costs Increase liquidity Brown Banana Co. Inventory turnover = 5 = sell in 73 days (365 days / 5 Inv turnover)

Inv turnover Days sales of inventory Bought too much and it spoiled Became obsolete before they could be sold. Why? We aren’t managing our inventory and sales very well. Bad marketing campaign Radioactive bananas

Inv turnover Days sales of inventory Too short? Hmmm. I guess I will go somewhere else Why? Customer Stock out We might not have enough inventory to support our sales. = stock outs

I think if your shelves didn’t look so empty, I would buy more. Inventory reorder point Psychic stock Cycle stock Just to be safe, I’ll ask my elves to build another 50 M girls bikes. Safety stock Why would we buy more inventory than we need?

Cycle stock Inventory turnover Stock outs Days sales of inventory Inventory carrying costs Customer satisfaction Safety stock Now why do we want more inventory? Psychic stock

Eff ec No tiv ea nd te no eff icie Inventory carrying costs nt inv e ug h nto ? ry pu rch ase sa nd s To om uc ale sp roc ess Missed sales es an dp roc ed ure s h?

Inventory Turnover = Cost of Goods sold Average Inventory = Beg. Inv. + End. Inv. 2

Inventory Turnover 5 = Average Inventory $200 Cost of Goods Sold $1, 000 Average Inventory $200 = Beg. Inv $170 + End. Inv $230 2

Days Sales of Inventory, Average Days to Sell 365 Days Sales of Inventory = 73 days 365 days per year Inventory Turnover Ratio of 5 Company’s average days of inventory Industry’s average days of inventory $200 COGS $200 Inventory purchase Day 1 Day 20 $200 COGS Day 73

Inventory Turnover Ratio Days Sales of Inventory = Cost of Goods Sold 365 days per year Average Inventory Turnover Ratio If you know 3 out of the four variables, you can solve for the fourth variable. Inventory Turnover Ratio 13. 03 Average Inv. ? ? ? $3. 07 M = = Cost of Goods Sold $40 M Days Sales of Inventory 28. 01 days 365 days per year Inv. Turnover Ratio 13. 03

Inventory Turnover Ratio Year X 1 30. 12 Year X 2 27. 39 Year X 3 22. 87 Year X 4 18. 41 Year X 5 13. 72 Year X 6 13. 03 Days Sales of Inventory Year X 1 12. 12 Year X 2 15. 96 Year X 3 15. 96 Inventory carrying costs Year X 4 19. 83 Year X 5 26. 60 Year X 6 28. 01

Yellow Banana Co. Inventory turnover = 60 = sell in 6. 08 days (365 days / 60 Inv. turnover) Banana Industry Inventory turnover = 84. 89 = sell in 4. 3 days (365 days / 84. 89 Inv. turnover)

Summary • Be able to define and compute: – Inventory turnover ratio and days sales of inventory • Use the two ratios to assess management as compared to: – its own past – its industry

Introduction to Accounting Preparing for a User’s Perspective Compute and understand the Inventory Turnover ratio By Kevin C. Kimball, CPA with support from Debits and Credits Trainer www. canvas. net Free Jan. 2014 Available on the Google Play Store