Page 123 - Finance for Non-Financial Managers

Siciliano07.qxd 3/20/2003 11:23 AM Page 104
Finance for Non-Financial Managers
104
Days Sales Outstanding
borhood of 45 days, with
(DSO) A measurement of
some companies experi-
the relatioinship between is said to be in the neigh-
accounts receivable and sales. A high encing even longer delays.
number indicates slowing collection, a With that in mind, a stan-
bad sign for cash flow. dard anywhere in the 40-
to-50-day range is proba-
bly acceptable in most cases. Of course, DSO by itself doesn’t
tell the whole story. To be certain there isn’t a problem, this
metric should be reviewed along with the age of the accounts.
Inventory Turnover
For all the reasons mentioned before, the faster inventory gets
sold, the better for everyone watching the income statement
and the bank account. If it’s selling, it’s usually not getting
spoiled, broken, or lost. That’s why companies try to keep their
inventories as low as possible, consistent with being able to
promptly service customer orders. A key metric, therefore, is
inventory turnover—how quickly inventory is leaving the plant
and being replaced by new inventory. This measurement looks
like this:
Annual Cost of Goods Sold = 475,000 x 12
Average Inventory 591,000 = 9.6
If Wonder Widget’s inventory turnover ratio is 9.6 times,
then inventory is being replaced on average 9.6 times a year
and there’s a little more than one month’s inventory on hand at
all times (actually 1¼ months’ worth, or 12 ÷ 9.6), on average.
You’ll note, incidentally, that we didn’t give you
enough history to com-
Inventory turnover A pute average inventory or
measurement of how annual cost of sales, so we
quickly inventory is leaving used what we had, one
the plant and being replaced by new month’s cost of goods sold
inventory. A high turnover rate means
x 12, and the inventory
inventory moves quickly, which is
good for cash flow and for minimizing balance shown on our sole
inventory losses. balance sheet. This calcu-