◼️ What is Inventory (in simple terms)?
“Stuff I’m trying to sell.”
◼️ Where can I find it?
On the balance sheet.
(Current Asset)
◼️What do people often call it?
No typical shorthand name for this, but sometimes abbreviated “Inv”
◼️How do I forecast it?
We need something called the DOH or “Days on Hand”
◼️Again — simple terms?
DOH = “how many days of supply I have.”
Or: “how many days until I run out of Inventory.”
◼️Example:
DOH of 90 = on average we hold 90 days (or ~3 months) of Inventory supply.
Or said another way, “if we didn’t buy any more Inventory, we’d run out in 90 days.”
◼️Okay so how do I calculate DOH?
DOH = (Inv / COGS) x Days gone by
◼️Example:
— Sales = $12mm
— Gross Margin = 49%
— COGS = $6.12mm ($12mm x 51%)
— Inv = $1.5mm
— Time = 1 year
— DOH = ?
DOH = (Inv / COGS) x Days gone by
DOH = ($1.5mm / $6.12mm) x 365
DOH = ~89.5 days
— — —
Okay now that we’ve got DOH, let’s shift gears and forecast Inv.
But let’s think through the big picture first…
I need DOH to forecast my Inv…
and I needed COGS and Inv to get my DOH.
So —
To get my Inv forecast I need:
◼️ COGS, and;
◼️DOH
(and I have both now)
So I just need to flip the formula around a little bit, like this:
Inv = (DOH / Time gone by) x COGS
◼️ So let’s reverse the example above:
— DOH = ~89.5
— Sales = $12mm
— Gross Margin = 49%
— COGS = $6.12mm ($12mm x 51%)
— Time = 1 year
— Inv = ?
Inv = (DOH / Time gone by) x COGS
DOH = (~89.5 / 365) x $6.12mm
Inv = $1.5mm
— — —
So to keep it simple in your financial model…
𝗷𝘂𝘀𝘁 𝗰𝗮𝗿𝗿𝘆 𝗳𝗼𝗿𝘄𝗮𝗿𝗱 𝘆𝗼𝘂𝗿 𝗹𝗮𝘁𝗲𝘀𝘁 𝗗𝗢𝗛 𝗰𝗮𝗹𝗰𝘂𝗹𝗮𝘁𝗶𝗼𝗻.
(b/c that’s the best info you have).
And that DOH number goes from being a calculation to an 𝙖𝙨𝙨𝙪𝙢𝙥𝙩𝙞𝙤𝙣.
— — —
So now let’s pretend you think next year’s sales will grow by 5%:
Our $12mm of sales x 1.05 = $12.6mm forecast for next year.
And let’s keep our DOH the same at ~89.5 (because it’s an 𝙖𝙨𝙨𝙪𝙢𝙥𝙩𝙞𝙤𝙣 now)
What will our estimated Inv be at the end of next year?
Let’s just run the formula again:
(don’t forget to calculate COGS first!)
— Sales = $12.6mm
— Gross Margin = 49%
— COGS = $6.43mm ($12.6mm x 51%)
Inv = (DOH / Time gone by) x COGS
Inv = (~89.5 / 365) x $6.43mm
Inv = ~$1.58mm ✅
Great news: you can just build this formula to run automatically in each column of your model 👍
— — —
So to close out, let’s say it in words b/c that’s the key to understanding it.
(this is what I’d say to my boss in an email):
“For next year if we assume 5% sales growth and a gross margin of 49%, I expect our year-end Inventory to be about $1.58 million b/c on average we keep about ~89.5 days on hand.”
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