Posts Tagged ‘inventory days on hand’

Excessive Inventory Can Be a Burden

This continues a series of posts focusing on how to manage cash and how managing assets, expenses, and liabilities impact it. Along with accounts receivable which I discussed in Read the rest of this entry »

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Cash is a Necessity and Not a Luxury

Some companies think they are financially strong because they have lots of assets. But the makeup of those assets makes a big difference. What do I mean by that?

Can You Spend It

I touched on this earlier in the posting Read the rest of this entry »

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Make Profit Count

Ever wondered why a company that seemed to be doing so well suddenly failed? Often times the reason is that management took their eyes of the ball, with the ball being defined as cash. I touched on this earlier in Cash Flow – The Bottom Line. Basically the issue comes down to realizing that in order to make profit count it is essential that profit is converted to cash.

Cash is Critical

Without adequate cash a company will be hard-pressed to pay bills. I’ve had clients and been an employee of companies that were very profitable on paper. But, that’s on paper only. If you looked only at Read the rest of this entry »

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The Cash Conversion Cycle

If you read my postings on a regular basis I may sound like a broken record with how much I focus on cash. But again, as I’ve said before, “Profit is nothing until it is converted to cash.” See Cash Flow – The Bottom Line. Now I want to delve into how efficiently we convert financial activity to cash.

Cash Conversion Cycle Formula

First we need to identify some abbreviations and definitions: Read the rest of this entry »

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Accounts Payable Days Analysis

I’ve written extensively about how important cash is to a business. The accounts payable days analysis is an indicator of how well you are managing cash. This measure is also known as the days payable outstanding.

Are Your Vendors Happy?

We all know how important it is to keep customers happy. Don’t meet their needs or make them mad and they may leave you. Even worse, their comments may cause others to leave with them. Just like customers, you also need to keep vendors happy. If you don’t you may find your credit line cutoff and that you cannot get essential products and services. Imagine what happens when you cannot get the product you need to sell or use in your manufacturing process. Pretty soon it impacts your company’s ability to satisfy customers. The accounts payable days analysis is a statistic you can calculate that indicates how good of a job you are doing managing accounts payable and keeping your vendors happy.

The Calculation

The calculation is straight forward using the formula:

(Accounts Payable / COGS) * 365 where COGS is cost of goods sold.

Granted that the COGS does not include every expense that goes through accounts payable, but this is the basic formula. With that said, let’s look at an example of the accounts payable days analysis. If your accounts payable balance is $500,000 and your annual cost of goods sold is $2,000,000 the calculation is:

($500,000 / $2,000,000) * 365 = 91.25 days. This seems like a lot, but it is important to consider your industry’s average days for paying vendors. If the industry average is 120 days, then by comparison your company does not look that bad. On the other hand, if the industry average is 45 days then this is an indication you may be getting ready to experience difficulties with your vendors if you haven’t already. Of course the days payable outstanding is only one thing to consider. Your company may not have the financial clout of your competitors and vendors may keep you to a tighter leash. If so, you will need to earn their trust. Basically, managing accounts payable should be made a priority. Unfortunately, like the balance in the cash account, the issue is not with the accounts payable account itself. The balance in this account is the result of activity in other areas.

Some Causes and Solutions

Probably the three biggest causes of the accounts payable days analysis being too many days are the following:

  • Too much inventory or the wrong mix of inventory, thus having too many days of inventory supply
  • Too many days of accounts receivable outstanding, resulting in not realizing cash from sales in a timely manner
  • Gross profit margins are too low

I have discussed the issues with accounts receivable (See Accounts Receivable Days Outstanding Analysis) and inventory (See Inventory Days on Hand Analysis) to show the impact of not managing these diligently. In a future posting I will discuss the importance of adequate gross margin.

All that said, the quickest ways to get accounts payable under control is to address the accounts receivable days outstanding and the days of inventory on hand. With accounts receivable this involve your customer credit policies and staying on top of collections. With inventory you will need to analyze the balance on hand by item and see which items are overstocked. With both accounts receivable and inventory you can use the 80/20 rule to help you decide where to start. See the blog posting 80/20 Rule for Receivables Management for how this works with accounts receivable.

Next Steps

I encourage you to make the accounts payable days analysis to see just how well you are doing. AimCFO is here to help if you need it or are just not sure how to go about this process.

If you want to know more, contact AimCFO – Contact

As always, your comments are welcomed.

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Inventory Days on Hand Analysis

In two articles around three years ago called 3 Low Cost Sources of Cash – Part 1 and Small Inventory – Big Benefits I discussed some of the benefits of keeping inventory to a level that would meet needs but would not be excessive. Let’s now look at a way to analyze inventory called inventory days on hand.

The Formula

The calculation for inventory days on hand is straight forward and is as follows:

(Inventory Balance / COGS) * 365 where COGS stands for Cost of Goods Sold. Let’s use the same numbers used in the first article mentioned above. If the inventory on hand is $1,000,000 and the annual cost of goods sold is $3,000,000 then the inventory days on hand is calculated as follows: Read the rest of this entry »

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