The weeks of inventory on hand shows the average amount of time it takes a business to sell the inventory it holds. This measure is often expressed in terms of days, rather than weeks. The calculation is essentially the same except for the unit of time used. Weeks of inventory is sometimes called the weeks' sales ratio. Weeks of inventory on hand measures only the time needed to sell the aggregate value of a firm's inventory. This is mainly of interest to external financial analysts and stakeholders who want to evaluate a company's performance. Company managers usually prefer to rely on data about specific products to assess inventory levels.
Inventory on Hand Overview
A business needs to keep enough inventory on hand to meet customer demand. However, inventory represents a substantial commitment of working capital. In addition, holding inventory incurs costs. An excessive amount of inventory on hand therefore tends to reduce the profitability of a firm.
When the days or weeks of inventory on hand is small, it is seen as a plus by financial analysts because this means the company is moving its stock efficiently. By contrast, a large figure for weeks of inventory indicates excess and possibly obsolete goods sitting on the shelves. There are two ways to calculate weeks of inventory on hand. They yield the same results, so you can use whichever is more convenient.
Calculating Weeks of Inventory
One way to calculate weeks of inventory on hand is to divide the average inventory for the accounting period by the cost of goods sold for the same period and multiply by 52. The cost of goods sold is stated on a company's income statement. To determine the average inventory, look on the firm's balance sheet for the beginning and ending inventory for the period. Add the beginning and ending inventory and divide by two to get the average. Suppose the cost of goods sold equals $3 million and the average inventory equals $600,000. Divide $600,000 by $3 million and multiply by 52. The weeks of inventory on hand comes to 10. 4 or 10 weeks plus about three days.
Calculating Weeks of Inventory: Alternate Method
If you wish to use the alternate method for calculating weeks of inventory, on hand, divide 52 by the inventory turnover rate. The formula for inventory turnover is the cost of goods sold divided by the average inventory for the accounting period. If cost of goods sold equals $3 million and the average inventory equals $600,000, you have an inventory turnover rate of five. Divide 52 by five and the result is 10.4 weeks of inventory on hand or 10 weeks plus about three days.