Chapter 12
Using Accounting Information
372
Inventory Days on Hand
This ratio states the same thing as the inventory turnover ratio but in a different way.
Inventory
days on hand
is equal to the average number of days that it took to turn over inventory during the
year. Some users prefer to use this ratio because they are familiar with working in units such as days
and months.The formula is shown below.
=
365
Inventory Days on Hand
Inventory Turnover Ratio
This ratio converts the number of times inventory is turned over into the average number of days
it took to turn over inventory. For example, a company that sells its entire inventory twice a year
would have an inventory turnover ratio of 2 and an inventory days on hand of 182.5 days.The ratio
is calculated for Second Cup in Figure 12.21.
2014
2013
Days in a Year
365 days
365 days
Inventory Turnover Ratio
44.6
31.2
Days Inventory on Hand
8.2
11.7
Industry Average
14.1
15.8
_______________
Figure 12.21
The lower the result, the faster inventory is sold on average. This means that on average it took
just over a week for Second Cup to sell the inventory on hand in 2014. It likely purchased new
inventory once a week to keep its products fresh.This is a sign of good inventory management.
Leverage Analysis
There are two ways to finance a business: debt and equity. Debts are the liabilities of the business,
such as bank loans and accounts payable. Equity is generated by selling shares and generating
profits.
Leverage
relates to the amount of debt and risk the company has. Companies often take
on debt to finance the purchase of large assets. It then uses these assets to expand operations and
generate sales. However, there is usually a high cost of debt in the form of interest expense, which
is where the risk comes in.The company must be able to increase profits by more than the interest
expense to benefit the shareholders. One measure of leverage is the debt-to-equity ratio.
