Chartered Financial Analyst (CFA) Level 1 Practice Exam

How is Days of Inventory on hand calculated?

1. Inventory turnover / days in accounting period

2. Days in accounting period / inventory turnover

3. Cost of goods sold / average inventory

4. Average inventory / total sales

The correct answer is: Days in accounting period / inventory turnover

Days of Inventory on Hand is calculated by taking the days in the accounting period and dividing it by the inventory turnover ratio. This method gives a clear measure of how many days, on average, inventory is held before it is sold. The inventory turnover ratio itself measures how efficiently a company is managing its inventory by showing how many times inventory is sold and replaced over a period. By using the days in an accounting period divided by this ratio, you can determine the average number of days that inventory remains in stock. For example, if a company has an inventory turnover of 12 times in a year (indicating they sell and restock their inventory 12 times per year), you would calculate the Days of Inventory on Hand as follows: 365 days (in a year) divided by 12, yielding approximately 30.4 days. This means the company, on average, holds inventory for about 30 days before it is sold. The other choices do not yield the correct calculation for Days of Inventory on Hand. For instance, using inventory turnover directly as part of the numerator would not align with understanding the average holding period, and the other choices misrepresent inventory metrics.