The average inventory investment period can be used to determine the effect of different inventory investment periods on your business's cash flow. Using the average inventory investment period will help you understand how a change in the average period affects your cash flow. This is best illustrated by the following chart.
Cost of Goods Sold per Day | |||||
---|---|---|---|---|---|
Average Inventory Investment Per. (days) |
$200 | $300 | $400 | $500 | $600 |
Investment in Inventory | |||||
70 | $14,000 | $21,000 | $28,000 | $35,000 | $42,000 |
80 | 16,000 | 24,000 | 32,000 | 40,000 | 48,000 |
90 | 18,000 | 27,000 | 36,000 | 45,000 | 54,000 |
100 | 20,000 | 30,000 | 40,000 | 50,000 | 60,000 |
110 | 22,000 | 33,000 | 44,000 | 55,000 | 66,000 |
The above chart illustrates the effect a change in the average investment in
inventory has on the investment in inventory for your business. Remember,
inventory is money that cannot be used for other cash outflow purposes until the
inventory is actually sold. For example, assume that your cost of goods sold per
day is $300, and that your average inventory investment period is 100 days. Now
assume that you were able to reduce your average investment period from 100 days
to 70 days. From the illustration above, you can see that the reduction in the
average inventory investment period reduces the investment in inventory from
$30,000 to $21,000. This reduction generated an additional $9,000 in your cash
flow!