January 18, 2022

Accounting + Finance Blog

Finished Goods Conversion Period and Key Explanations

Another aspect of the inventory conversion period is the finished goods. Especially for manufacturing firms, goods are transformed from raw materials to finished goods. But after that, they are sold for cash or on credit. Knowing this aspect is important as it tells you more about the power of the company’s personnel to sell off available products and re-producing them for sale. Let’s discuss!

Definition of Finished Goods Conversion Period

1. Finished goods conversion period is the time it takes to make a company’s products available for sale and sell them for cash or credit terms.
2. You can define it as the part of the inventory conversion period that involves the timeframe a business sells its completed products to customers.

Key Explanations

First of all, raw materials are purchased by the manufacturing firm. This is processed in various stages before they are completely or ready for sale. Next, these goods will be sold to the clients and customers.

It is interested in the length of time the completed product is sold. Once goods are ready for sale, it is likely stored in a warehouse or sold immediately to wholesalers, agents or retailers.

The method used depends on the nature of the industry or how quickly marketers sold those products. This may also be influenced by the reputation of the firm as well as its popularity and market share. However, investors will like to put their cake into companies that have smaller finished goods conversion periods. Why? It tells them more about the management team.

How to Calculate Finished Goods Conversion Period

The formula for the finished goods conversion period is Average Finished Goods ÷ Cost of Goods Sold.

The final answer should be in days, weeks, or years.

Average Finished Goods = (Opening + Closing Finished Goods) ÷ 2

Worked Example

Below is a worked-through example. The example on the screenshot below will be solved.

From the formula above, the Average Finished Goods is (700,000 + 500,000) ÷ 2 = 1,200,000 ÷ 2 = 600,000

Next, the Finished goods conversion period = 600,000 ÷ 3,000,000. This equals 0.2. Also, 0.2 × 365 days gives 73 days.

This implies that the company used 73 days to sell completed products. It is not easy to determine if the day is okay unless you have an idea of how the industry works plus you have access to data for the industrial average of this conversion period.

Conclusion

The finished product conversion period is the time it takes to sell a firm’s products and remaking them. The calculation can tell a lot about a company. Such as if it has effective management and marketing executives. Investors can use this information to decide if investing in the company is the right choice.