Small question on ratios. In the working capital management reading in corporate finance they introduce some efficiency ratios. However, these ratios differ from those in the FRA book. For instance, in the Corp. Fin. book we have DOH=Inventory/(COGS/365) but in the FRA book we have DOH= Numbers of days in period/Inventory Turnover. Same thing for DSO.
When doing EOC questions on DOH, I tried both method but it led to 2 different answers (despite the fact that both answers were relatively close: 39 and 41 and that it led to the same correct answer). Can using one formula over another lead to errors or does the way CFAI construct questions takes into account that small difference in formula ?
You should get the same answer unless you’re using dif figures for inventory or number of days in the period.
Thanks for your answer Pokhim,
I partially found an answer to my question, the difference in answer is due to the averaging of beginning and ending inventory when calculating the inventory turnover ratio. In order to get the same answer when using the Number of days in period/ Inventory Turnover, we need to use ending inventory in the inventory turnover ratio calculation, which doesn’t make much sense since in both FRA and Corp. the formula for the inventory turnover is averaged. Its not because it is actually difficult to remember both formulae and use either one based on the context of the question, but it is a bit ambiguous.