Average days in inventory is calculated as \(\frac{365\ \text{days}}{\text{Inventory Turnover Ratio}}\). What does the denominator represent in this formula?

• A. Gross Profit Margin
• B. Current Ratio
• C. Inventory Turnover Ratio
• D. Accounts Receivable Turnover

Answer: (C)

Verified step by step guidance

1. Understand the formula for Average Days in Inventory: \( \text{Average Days in Inventory} = \frac{365\ \text{days}}{\text{Inventory Turnover Ratio}} \). This formula calculates the average number of days inventory is held before being sold.
2. Identify the denominator in the formula: \( \text{Inventory Turnover Ratio} \). This ratio measures how many times inventory is sold and replaced during a specific period, typically a year.
3. Clarify the meaning of Inventory Turnover Ratio: It is calculated as \( \text{Inventory Turnover Ratio} = \frac{\text{Cost of Goods Sold (COGS)}}{\text{Average Inventory}} \). This indicates the efficiency of inventory management and sales performance.
4. Relate the Inventory Turnover Ratio to the Average Days in Inventory: A higher Inventory Turnover Ratio means inventory is sold more frequently, resulting in fewer average days in inventory. Conversely, a lower ratio indicates slower inventory movement and more days in inventory.
5. Compare the denominator to other financial metrics mentioned: Gross Profit Margin, Current Ratio, and Accounts Receivable Turnover are unrelated to inventory turnover. The correct denominator in this formula is the Inventory Turnover Ratio, as it directly measures inventory activity.