2.6 Days’ Equivalent Ratios
The last section covered ratio-based forecasting in general. A specific case is worth highlighting separately, due to its frequent use: The Sales-Days’ Equivalent method. In this method, when an item is to be forecast as a proportion of Sales Revenue, the calculation is not defined through an explicit ratio of the sales (such as 10%), but by turning this ratio into a number of days (i.e. by multiplying the ratio by 365 or the number of days in a year). Thus “10% of annual sales” would be 36.5 days’ equivalent.
This type of calculation is often used for “stock” items, such as:
- The value of invoices outstanding (owed by customers) at any point in time.
- The inventory of finished goods at any point in time.
(These “stock” items have a value at a particular point in time, unlike (for example) Sales Revenues, which is a figure associated with a time period i.e. is a “flow” item).
Example
Let us assume that the amount owed by customers (invoices outstanding) at the end of the prior period is $8m:
If annual Sales Revenue were $100m, then the figures could be used to calculate either (or both of):
- The ratio of the amount Owed to Annual Sales, i.e. 8.0%.
- The “days’-equivalent”. The day’s equivalent i.e. approximately 29.2 days.
Note that – although the explanation of “days’-equivalent” refers to the ratio, the calculation in cell D9 does not refer to that in D8 (but is done with direct cell references to the cells D4 and D7). In other words, although the figure of 29.2 could be calculated as 8% of 365 (i.e. after having first calculated the ratio), very often in practice the ratio may not be calculated explicitly.
In practice, therefore one or other (but not both) of the methods would be used. The following image shows the calculations in the case that the Sales Revenue % was used as a ratio assumption to forecast the amount owed …:
… whilst the next image below shows the calculations in the case that the days-equivalent method were used:
(When comparing the two images above, note the differences between the images in the formulas in cells E7 and E8).
Note that (again, and in both cases) there is a logic reversal between the historical and forecast part of the model, shown in the following image:
Recommended Exercises
Please experiment building a days’ equivalent set of calculations, such as some of those above.