The income statement preparation method makes a (big) differenceĬompanies prepare their income statement either by using the nature of expense method or the cost of sales method. Therefore, it makes sense to read the note relating to inventories carefully, and deduct any such value, as it will likely distort the inventory days figure. Sales come into play only once the product has been sold, and therefore has nothing to do with the inventory days formula.ĭeduct the value of fixed assets held for sale from the inventory valueĬompanies often include the value of fixed assets held for sale within its inventory figure. We will not dig deep into the management accounting practices here, but it is important to highlight that during the manufacturing process, the value of the raw materials used is enhanced by allocating a portion of the variable manufacturing expenses, direct labour expenses, and direct and indirect depreciation and amortization, which in the end give a value of a finished good / product, which will be charged to the income statement once the product has been sold. When a company purchases raw materials it needs for its manufacturing processes, it will book them at cost in its balance sheet. The mark-up is realised only when the sale has actually been concluded. This is fundamentally wrong, as sales figure includes a mark-up added on top of the manufacturing costs. Sometimes the formula you will find in finance books includes sales instead of COGS. However, there are a few things that one needs to watch out for when using it. There is nothing wrong with this formula. Inventory days = Average Inventory / COGS * 365 In finance books you will most often find the following formula for the calculation of the inventory days:
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