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

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

If you hold Inventory too long it can: 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

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

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

Days sales of inventory Days sales of inventory 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 Inventory turnover Days sales of inventory

$0 cash inflow? Yellow Banana Co. Brown Banana Co. Inventory turnover = 60 Inventory turnover = 5 = sell in 6.08 days = sell in 73 days (365 days / 5 Inv turnover) (365 days / 60 Inv turnover) Sell before turn brown Sell at full price $.50 lb Lower inventory carrying costs Increase liquidity

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

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

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

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

Inventory carrying costs Not enough? Too much? Effective and efficient inventory purchases and sales processes and procedures Missed sales

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

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

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

Inventory Turnover Ratio Days Sales of Inventory = Cost of Goods Sold 365 days per year Average Inventory Inventory Turnover Ratio If you know 3 out of the four variables, you can solve for the fourth variable. Inventory Turnover Ratio 13.03 Days Sales of Inventory 28.01 days = = Cost of Goods Sold $40 M 365 days per year Average Inv. ????? $3.07 M Inv. Turnover Ratio 13.03

Inventory carrying costs Inventory Turnover Ratio Year X1 30.12 Year X2 27.39 Year X3 22.87 Year X4 18.41 Year X5 13.72 Year X6 13.03 Days Sales of Inventory Year X1 12.12 Year X2 15.96 Year X3 15.96 Year X4 19.83 Year X5 26.60 Year X6 28.01 Inventory carrying costs

Yellow Banana Co. Banana Industry Inventory turnover = 60 = sell in 6.08 days = sell in 4.3 days (365 days / 60 Inv. turnover) (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 Debits and Credits Trainer By Kevin C. Kimball, CPA with support from www.canvas.net Free Jan. 2014 Available on the Google Play Store