Asset utilization has many aspects, and there are several measures that may logically be used to gauge efficiency. Most important from an operating-cash-flow point of view are those asset-efficiency measures relating to inventory and accounts receivable. As explained earlier, these are most commonly measured in  days. How many days worth of sales are in accounts receivable, and how many days worth of cost of goods sold are in inventory?

These are both relative, or proportional, measures. Generally, as sales go up, the investment in inventory and accounts receivable tends to go up proportionally, thereby keeping the days measure the same. For example: If the average balance of outstanding accounts receivable is one-eighth of annual sales, then days receivable are 1/8 x 365 days = 46 days. Similarly for inventory: If average inventory value on hand is one-sixth of annual cost of goods sold, then days inventory are 1/6 x 365 days = 61 days.

This measure in days is a relative measure, which makes it ideal for period-to-period comparisons. It is far more useful than simply comparing absolute dollar values, which could easily be affected by other variables, including such things as growth, seasonality or other issues having no basic connection to the policies and practices by which receivables or inventory are managed. Other things being equal, the goal is to manage asset days (inventory or receivables) downward and liability days (payables) upward for maximizing cash flow. Although there is no necessary connection between these days measures, the underlying issues can certainly be intertwined. If, for example, one of your major suppliers offers longer-than-usual terms for
especially large purchases, then your inventory days and payables days are likely to both move upward proportionally. If, on the other hand, the offer isn’t longer terms but significantly lower prices on large buys, your inventory days will go up, payables will move little and the impact will register mostly in improved gross margins, unless, of course, you pass along the savings. And if you do pass along the savings, you may well wind up with a spike in sales. Everything that happens with a cash driver has to affect some other measure someplace.

Taken From : Cash Rules