The other conversion periods discourse earlier are part of the inventory time frame in a manufacturing company. For trading companies, the inventory conversion period is more straightforward. In this article, let’s focus on manufacturing firms.
Definition of Inventory Conversion Period
1. The inventory conversion period of the manufacturing firms is the time it takes to make and sell inventories that are in stock in a business.
2. It can be defined as the timeframe between buying raw materials, processing them to finished goods, and distributing the goods to clients/customers.
Time-Period. The shorter the timeframe, the inventory conversion period of manufacturing firms, to make and sell inventory the better for the business. With this, the entity can buy more raw materials and pay debts quickly. It also gives the company trust from investors/shareholders. The reason? Shareholders will believe that their investments are optimally utilized.
Raw materials/work-in-progress/finished goods. The entity buys raw materials, processes them as work-in-progress to finished goods. Then, sell the inventory to consumers. To explain further, a bread manufacturer’s raw materials may comprise flour, sugar, butter, milk, and more. These ingredients are processed into bread (finished goods) before they are sold to consumers.
The formula for Inventory Conversion Period
The formula for the inventory conversion period for manufacturing firms is:
Raw material conversion period + Work-in-progress conversion period + finished goods conversion period
I have explained and calculated each of these periods earlier. Read. In this article, I will combine three of these to get the inventory conversion period for a manufacturing firm.
Example and Solution
I have calculated the conversion period for each of the aforementioned. So, all I need to do is add them up. This is what you can see in the screenshot below.
The inventory conversion period for the hypothetically manufacturing firm here is 154.86 days. This is a longer period, considering that a year is 365 days. But, you can’t conclude the period only from one year. You will need to compare it with other years. You may also compare with other companies in the same industry.
An inventory conversion period for a manufacturing firm tells the time it takes to make and sell inventory. A shorter period is good for business. Moreover, the sum of raw materials conversion period, work-in-progress conversion period, and finished goods conversion period makes up this term.