Using Average Inventory Investment

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!