Activity Based Risk Evaluation Model of Auditing

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Days sales in inventory

Days sales in inventory

=

Inventory at end of period / Average daily cost of sales

This is one of the many ratios used by auditors in ratio analysis. As with other ratios, the auditor compares the actual value of the ratio at a point of time with the expected value of the ratio and investigates any unexpected change.To avoid the actual value of the ratio biasing the auditor's estimation of the expected value, auditors estimate the expected value before calculating the actual value.

Days sales in inventory provides an estimate of the number of days, on average, that it takes to sell inventory. The value of inventory in the ratio includes the value of work in progress. Average daily cost of sales is equal to total cost of sales divided by 365 (although other divisors may be used, for example, the number of working days in a year). A ratio value of say, 33 days, indicates that it takes, on average, 33 days to sell inventory. By itself, however, the ratio does not convey a lot of meaning. Comparison of the ratio provides more meaningful information. For example:

• comparison of the ratio with an industry average (ensuring the method of calculating the industry ratio is the same method used to calculate the client's ratio). This provides an indication of whether the client is performing better or worse than the industry as a whole. The comparison is useful when obtaining a preliminary knowledge of the client's business.
• comparison of the ratio between different entities or divisions within a group. This comparison is useful when obtaining a detailed knowledge of the client's business and provides an indication of which entities or divisions may require particular attention.
• comparison of the ratio this year with last year. An increase in the ratio over the previous year may be an indication that (certain) product lines are taking longer to sell, or that the account balance includes inventory which should be written off; a decrease in the ratio may be an indication that production control is more effective. In many businesses, this ratio remains relatively unchanged from year to year, so even a small change (e.g. from 35 days to 36 days) may require investigation.

Other ratios used by auditors include:

• Gross profit ratio
• Days sales in receivables
• Inventory turnover

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