In order to calculate the number of days involved in each part of the process, some estimates may have to be made. The date may be available and it may need to be updated occasionally, in order to obtain a more realistic result. Or it may simply need to be estimated. The following formulas will indicate the figures that are needed.
The average number of days raw materials are in inventory can be calculated as:
Average raw materials inventory / Average annual purchases x 365 = Days of raw materials inventory
Average days in work-in-process are calculated as:
Average balance of work-in-process inventory / Average annual cost of production x 365 = Days of work-in-process inventory
Average days of finished goods inventory are:
Average balance of finished goods inventory / Average annual cost of sales x 365 = Days of finished goods inventory
Terms with Suppliers and Customers
The other periods involved in the cycle are the average payment terms with suppliers for purchases of materials, the average payment period for other expenses, and the average credit terms with customers for sales. With this information, the first stage of calculating working capital needs based on days of sales to finance is complete. The next stage involves assigning values to these periods.
Number of Days
Based on the above calculations, an example could be generated, as follows:
Days of raw materials inventory = 5
Days of work-in-process inventory = 15
Days of finished goods inventory = 10
Payment terms with suppliers = 30
Payment terms for other expenses = 10
Credit terms with customers = 45
This information may be available from historical records on production, or based on personal experience in the business. Or it may be based on contractual terms, such as payment terms with suppliers and credit terms with customers.