Introduction to Corporate Finance

Ross et al.: Fundamentals

of Corporate Finance, Sixth

Edition, Alternate Edition

II. Financial Statements

and Long−Term Financial

Planning

3. Working with Financial
   Statements

(^100) © The McGraw−Hill
Companies, 2002
If we know that we turned our inventory over 3.2 times during the year, then we can
immediately figure out how long it took us to turn it over on average. The result is the
average days’sales in inventory:
Days’ sales in inventory 
 114 days

[3.13]

This tells us that, roughly speaking, inventory sits 114 days on average before it is sold.

Alternatively, assuming we have used the most recent inventory and cost figures, it will

take about 114 days to work off our current inventory.

For example, in March 2001, Ford had a 57-day supply of cars and trucks, slightly

less than the 60-day supply considered normal. This means that, at the then-current rate

of sales, it would have taken Ford 57 days to deplete the available supply, or, equiva-

lently, that Ford had 57 days of vehicle sales in inventory. Of course, for any manufac-

turer, this varies from vehicle to vehicle. Hot-sellers, such as the Chrysler PT Cruiser,

were in short supply, whereas the slow-selling (understandably!) Pontiac Aztek was in

significant oversupply. This type of information is useful to auto manufacturers in plan-

ning future marketing and production decisions.

It might make more sense to use the average inventory in calculating turnover. In-

ventory turnover would then be $1,344/[($393 422)/2] 3.3 times.^5 It really depends

on the purpose of the calculation. If we are interested in how long it will take us to sell

our current inventory, then using the ending figure (as we did initially) is probably

better.

In many of the ratios we discuss in the following pages, average figures could just as

well be used. Again, it really depends on whether we are worried about the past, in

which case averages are appropriate, or the future, in which case ending figures might

be better. Also, using ending figures is very common in reporting industry averages; so,

for comparison purposes, ending figures should be used in such cases. In any event, us-

ing ending figures is definitely less work, so we’ll continue to use them.

Receivables Turnover and Days’ Sales in Receivables Our inventory measures

give some indication of how fast we can sell product. We now look at how fast we col-

lect on those sales. The receivables turnover is defined in the same way as inventory

turnover:

Receivables turnover 

 12.3 times

[3.14]

Loosely speaking, Prufrock collected its outstanding credit accounts and reloaned the

money 12.3 times during the year.^6

This ratio makes more sense if we convert it to days, so the days’sales in receiv-

ablesis:

$2,311

$188

Sales

Accounts receivable

365 days

3.2

365 days

Inventory turnover

68 PART TWO Financial Statements and Long-Term Financial Planning

(^5) Notice that we calculated the average as (Beginning value Ending value)/2.
(^6) Here we have implicitly assumed that all sales are credit sales. If they were not, then we would simply use
total credit sales in these calculations, not total sales.