Inventory is cash in another form
Every carton on the shelf is money you paid to the supplier that has not yet come back to you. The longer it stays, the higher its hidden cost: rented space, bank financing or a lost investment opportunity, the risk of damage, obsolescence or expiry, and the effort of counting and arranging. That is why accountants measure how fast inventory moves with two simple indicators.
Slow-moving stock in particular does not show up in the accounts as a problem until it builds up; its balance stays in the statement of financial position at cost as if it were a sound asset, while its real market value may be much lower.
Turnover and days of inventory
- Inventory turnover = Cost of goods sold ÷ Average inventory
- Average inventory = (Opening inventory + Closing inventory) ÷ 2
- Days inventory outstanding (DIO) = 365 ÷ Turnover
Use cost of goods sold, not sales, because inventory is recorded at cost. Using sales shows a higher turnover than the real one.
An auto parts store in Riyadh:
| Item | SAR |
|---|---|
| Cost of goods sold for the year | 1,800,000 |
| Inventory at the start of the year | 500,000 |
| Inventory at the end of the year | 700,000 |
| Average inventory | 600,000 |
- Turnover = 1,800,000 ÷ 600,000 = 3 times a year
- Days of inventory = 365 ÷ 3 = approximately 122 days
This means a riyal invested in inventory takes about four months on average to come back. If the store raised its turnover to 4 times with cost of sales unchanged, the required average inventory would fall to 450,000 SAR, freeing up 150,000 SAR in cash.
The average hides the details: the inventory aging report
A turnover of 3 times may mean that all items move regularly, or it may mean that half of them fly off the shelves while the other half has not moved for a year. That is why you need an inventory aging report, which classifies the balance of each item by the date of its last sale.
| Last sale | Value at cost (SAR) | Percentage |
|---|---|---|
| Within 90 days | 455,000 | 65% |
| 91 to 180 days | 84,000 | 12% |
| 181 to 365 days | 63,000 | 9% |
| More than a year | 98,000 | 14% |
| Total | 700,000 | 100% |
This is where the frozen money shows: 161,000 SAR of which nothing has been sold for six months or more, including 98,000 SAR for more than a year. These are often parts for car models that have become rare on the market, or quantities bought at a large discount beyond what was needed.
The accounting effect of slow-moving stock
Under International Accounting Standard 2, inventory is measured at the lower of cost and net realizable value. Net realizable value is the expected selling price less the costs of completing the sale.
A slow-moving item costs 98,000 SAR. After studying the market, the most it can be sold for is 60,000 SAR, with disposal costs (commission and delivery) of 5,000 SAR.
- Net realizable value = 60,000 − 5,000 = 55,000 SAR
- Required write-down = 98,000 − 55,000 = 43,000 SAR, charged to the income statement
Ignoring this write-down overstates assets and profits, and may draw a finding from the external auditor.
After the write-down
When the item is later sold for 60,000 SAR, only a small profit or loss will appear in the income statement, because the main loss was recorded earlier. And if the market improves and net realizable value rises before the sale, part of the write-down is reversed under the standard to the extent of the increase, limited to the amount originally written down. That is why it is best to document the basis of the estimate for each item: price quotes, recent selling prices, or the purchasing manager's opinion.
Practical steps to free up frozen money
- Run the aging report every quarter and assign a person responsible for each item older than 180 days.
- Stop automatic reordering of slow-moving items; much of the stagnation is caused by purchase orders repeated out of habit.
- Clear stock with a plan: bundle offers, sales to other traders or workshops, or returns to the supplier if the agreement allows.
- Review purchasing limits: a volume discount is not worth it if the quantity will sit on the shelf for a year.
- Track the indicator monthly for each item category, not only for inventory as a whole.