Inventory Turns and Days of Supply

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Inventory turns is one of the key performance indicators used in measuring the supply chain performance. It is used in measuring inventory turnover, which is useful in calculating the cost of annual sales per inventory unit. It is measured by dividing the cost of goods sold over average aggregate value of inventory.

Cost of goods sold is the total amount of goods that have been sold over a specified period. Average aggregate value of inventory is average value for an item multiplied by its unit value. Inventory turn is computed by dividing the number of units sold (over a given period) by average number of units (for the period). Using the same unit of measure for the denominator and numerator is crucial in the calculation of inventory turns. It makes it possible to refer to the same unit and gives more accurate number of inventory turns.

For example, from a company’s statement of financial position, one can derive the cost of goods sold to be $8,000,000. The average inventory value for X Company between 2010 and 2012 is $2,000,000. Using the formula above, inventory turn for company X is given by:

Cost of goods sold for the current year = $8,000,000

Average inventories =$2,000,000

Inventory turn= cost of goods sold/average aggregate value of inventory =$8,000,000/$2,000,000= 4

Therefore, the number of inventory turns for company X is 4. This means that company X sells its entire inventory 4 times a year. By comparing this value with that of company X competitors, one is able to identify whether the company is performing better than its competitors in the same industry.

For example, assuming company X operates in a textile industry that has an average turnover of 6.2, it can be concluded that the average turnover for company X is lower than that of its competitors. Although company X has a lower turn rate than its industry average, it does not necessarily mean that the company is weak. Further analysis of the balance sheet should be carried out to reveal how strong or weak its inventory turnover is in the industry.

This is because they vary from industry to industry. Retailers and small vendors’ shops have a higher rate of inventory turn because they sell products that are cheap or affordable and are bought more often. However, the rate of inventory turn for companies that produce, sell or manufacture large machineries such as jets and expensive automobiles are lower since their products are expensive.

Days of Supply

Inventory days of supply are computed by dividing the value of average inventory over costs of goods sold in a year (365 days). When one has an inventory turn rate, it is easier to calculate the inventory days of supply. There are 365 days in a year and company X clears its inventory 4 times a year.

Therefore, the number of days using the formula is equal to the number of days in a year divided by the number of times the company clears its stock. 365/4= 91.25. It can also be computed by dividing the average value of inventory by costs of goods sold over a year. That is;

Cost of goods sold= $8,000,000

Average value of inventory=$2,000,000

Days in a year= 365

Using the formula

Days of supply = average value of inventory/ (costs of goods sold/365 days)

= $2,000,000/ ($8,000,000/365 days)

=$2,000,000/ 21917.8

=91.2500

=91 (average number of days of supply).

This means that it takes an average of 91 days for company X to clear its inventory

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Inventory Turns and Days of Supply

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