Empower your business to convert to sales for Inventory

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hello friends my name is jeeraj vaddy from wallstreetmojo.com this is part 11 of our ratio analysis video series and in this installment we learn all about day's inventory in simple terms days inventory tell you how many days it takes for a firm to actually convert its inventory into sales so in this tutorial we basically have four objectives number one look at what days inventory actually mean number two what is formula and the calculations number three calculate days inventory for colgate and number four what its interpretations so before we jump into the tutorial a quick reminder for you we will be needing all the working files of colgate case study for this video so if you haven't downloaded it yet please do so from the description link below and also to keep yourself updated with the investment banking and core finance concepts please do subscribe to our channel wallstreetmojo so let's get started [Music] what is inventory days inventory days is a part of the ratio analysis framework and it comes under the category of turnover ratios in our last video we discussed about the inventory turnover ratios and if you look at the days inventory or the inventory days both of them are actually very very closely related it's just that the way we interpret and show it is slightly different on one side inventory turnover ratios essentially means how many times you are processing the inventory turning the inventory from the raw material to work in progress to finished goods and finally the sales process so how many times you are turning the inventory into you know sales so if it was two you are doing that for two times during a year but when you talk about days inventory or inventory days we look at the same thing in number of days so we say that how many days a company might take to process the raw material to work in progress work in progress to finish goods and from finished goods to the final sales process how long does this cycle takes in number of days is called as inventory days so if the inventory turnover ratio was two here what will be the number of days inventory days we will see we will see using the formula that we will use next let us now look at the formula of inventory days and how it is calculated so uh basically it's a two-step process the first step is to calculate the inventory turnover ratio this we learned in the last video and if you want to know more about it you can refer to our previous video the formula is fairly simple you divide the cost of goods sold divided by the average inventory so average inventory is the beginning inventory and the closing inventory and you divide that number by two once you have found out the inventory turnover ratios calculation of inventory days is very simple you just divide 365 by the inventory turnover ratio so that's how you will find out the inventory days or days in inventory so let's do a quick calculation we'll pick up the previous example which we did and we'll calculate you know how much is the inventory days here okay so we are provided with this cost of goods sold which is 60 000 beginning inventory as a 40 000 ending inventory as 20 000 the first step is to calculate the average inventory because we want to calculate the inventory turnover ratio inventory turnover ratio is what cost of goods sold divided by average inventory so i am calculating the average inventory right now here so for doing that i use this average formula so here it is average inventory okay so the first step is to calculate the inventory turnover ratio so how much is the inventory turnover ratio in this case this will be cost of goods sold 60 000 divided by 30 000 so that comes out to be 2.0 now the second step the second step is basically to calculate the inventory days right how is inventory days calculated entry days is calculated as 365 divided by how much inventory turnover ratio okay so uh this is 2 here in our case so we get this answer as 182.5 days what does this mean it essentially means that the company takes 182.5 days to process the inventory from the raw material to work in progress work in progress to the final finished goods and then finally completing the sales process so the whole cycle takes 182.5 days and they do it two times during a year so that's how uh you know the final calculation of inventory days comes into picture okay with this i guess we can move forward and look at the calculation of inventory days for colgate so here is the balance sheet of olgate and i want you to scroll down to row number row number 114 this is where the average inventory processing days or the inventory days will be calculated if you remember how do we calculate inventory processing days or inventory days it was a two-step process the first step involved calculation of inventory turnovers and then you divide the 365 by the inventory turnovers to find out the inventory days if you remember from our previous video we did the calculations for inventory days and it was 5.16 for 2017 and then as we can see from the trend it's continuously reducing so how much it boils down to the number of days we will get that idea from the inventory date calculation here okay so since the first step is already done it becomes fairly simple we just need to divide 365 by the respective inventory turnovers okay so here this is equal to 365 divided by 5.16 so that will give us the inventory turnover days for 2017 all right so it comes out to be 70.7 okay i want this to be an absolute reference so i'll press f4 here because i don't want to write 365 every now and then or change the formula so i'll just put it like this as a absolute reference by putting the dollar signs here and here the shortcut is f4 and press enter and when i copy this formula you will note that the references have not moved okay so only this portion moves the absolute reference doesn't move at all so it's freezed at single cell in terms of the trend what do we see earlier uh cool gate was taking around 70.7 days to process the inventory but now it is taking around 86.9 days so it's taking a bit longer than what it used to in 2017. is it a good situation to be in prima facie looking at the trend it doesn't look like a good situation and if we compare this with the proctor and gambles doctrine gambles had an inventory turnover ratio between seven and eight let's assume it was a seven how much will this become this will come out to be 52.14 procter gamble takes 52.14 days to process its inventory and as compared to procter gamble's colgate takes 86.9 days obviously uh colgate is not in a good position vis-a-vis procter gamble and they might have to work hard towards their inventory processing days okay so this is how you know we can you can interpret that this ratio by comparing it with the peers as such and if we compare this with procter gamble we note that the procter gamble's inventory turnover ratio was 13.5 so in order to find the inventory days we will have to just divide 365 by 13.5 so how many days do we get it's 27.037 days okay so 27 days is what we can take so compare this 27 days with 86.9 days for colgate obviously procter gamble is doing an excellent job here that's how you know you can interpret and contrast and compare it with appears and find out whether the company is doing good or not so i hope you understood what is inventory days you know how do you calculate it and how do you you know compare it with the peers i hope you found this video to be useful please do like and share and if you have any feedback want to suggest a topic for any future video then you may do so by writing about it in the comments section also we come up with interesting videos on investment banking and core finance topics regularly so if you haven't subscribed to our channel yet please do so by clicking on the subscribe button below so that you can get the notification about our latest videos i hope you enjoyed the video have a nice day