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Example: ($ IN MILLIONS) 2014 2013 Revenue $12,000 $10,000 Cost of goods sold $4,000 $3,200 Inventory $1,600 $2,500 Accounts receivable $680 $640 Accounts payable $1,100 $1,300 Average inventory ($1,600 + $2,500)/2 = $2,050 Average accounts receivable ($680 + $640)/2 = $660 Average accounts payable ($1,100 + $1,300)/2 = $1,200 Days' inventory outstanding $2,050/($4,000/365 days) = 187.1 days Days' sales outstanding $660/($12,000/365 days) = 20.1 days Days' payables outstanding $1,200/($4,000/365 days) = 109.5 days Cash conversion cycle 187.1 + 20.1 - 109.5 = 97.7 days
To highlight the insights this formula provides, consider a days' sales outstanding (DSO) example, where days' sales outstanding = accounts receivable/daily sales.