Stock On-hand Calculation Formula and Instructions
The Days of Inventory On Hand (DOH) is a crucial financial ratio that offers insights into a company's efficiency and cash flow management. This ratio, expressed in days, demonstrates the average number of days it takes a company to convert its inventory into sales.
Calculating DOH can be done in two ways. One method involves multiplying 365 by the average inventory, divided by the Cost of Goods Sold (COGS). Alternatively, one can divide 365 by the Inventory Turnover Ratio to arrive at the same result.
Management often uses DOH to make short-term forecasts about inventory and establish reorder points to ensure a smooth inventory flow. A lower DOH allows the company to have more capital to reinvest into the business. For instance, in the case of non-durable goods companies such as food, a lower DOH is essential to avoid costs from spoiled or rotting goods.
For retail businesses, inventory is often the biggest investment. A lower DOH helps management understand how long capital is tied up in inventory, which is particularly important for businesses with a significant inventory investment.
In the realm of accrual accounting, revenue is recorded when products have been sold and shipped, but cash is not necessarily increased. This is because companies may sell products on credit, which affects the relationship between DOH and cash flow.
Streamlining business processes and integrating information between suppliers, retailers, and production facilities can lower DOH. A reliable partner and technology support are necessary for lowering DOH. Increasing sales can also lower DOH by designing the right marketing mix.
Companies with historically low average days on hand inventory that contribute to high profitability and financial liquidity typically include fast-moving consumer goods firms, technology companies with efficient supply chains, and retailers employing just-in-time inventory systems. These firms benefit from reduced holding costs and improved cash flow.
However, it's essential to note that days of inventory on hand don't tell us how long it took the company to collect the money. The company recognizes revenue on its income statement, but it does not record an increase in cash but accounts receivable. This discrepancy between revenue recognition and cash inflow underscores the importance of understanding the nuances of financial ratios like DOH.
In conclusion, Days of Inventory On Hand is a valuable tool for businesses seeking to optimise their inventory management and cash flow. By understanding this ratio and implementing strategies to lower it, companies can enhance their efficiency, reduce holding costs, and improve their financial position.
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