Average Age of Inventory: Overview and Calculations
The average number of days a company takes to sell off its inventory is the average age of inventory. Analysts use this indicator to assess how effective sales are. Days Sales in Inventory (DSI) is another term for the average age of inventory.
Formula and Calculation of Average Age of Inventory
The formula to calculate the average age of inventory is:
Average Age of Inventory=C/G×365
What You Can Learn from the Average Age of Inventory
The average age of inventory provides information to the analyst about the inventory turnover rate at different companies. A corporation is more lucrative the sooner it can profit from its inventory. On the other hand, a business could decide to retain more significant inventory levels to support long-term planning initiatives or discounts. Although the statistic may be used to gauge efficiency, any conclusions drawn from it should first be verified by comparing it to other metrics, such as gross profit margin.
An essential statistic in sectors like technology that see quick product cycles and high sales is the average age of inventories. Inventory with a high average age may indicate improper inventory management or hard-to-sell inventory for a company.
The average age of inventory influences pricing decisions made by managers and purchasing agents, such as reducing the price of current inventory to sell items and boost cash flow. A company’s exposure to obsolescence risk increases as the average age of its inventory rises. The risk of obsolescence is the possibility that inventories will depreciate over time or in a weak market. A company may write off inventory for a portion of its value below what is shown on its balance sheet if it cannot transfer the inventory.
An Example of Using the Inventory’s Average Age
An investor chooses to contrast two department stores. Company A’s COGS is $600,000, and its inventory is $100,000. By dividing the average inventory cost by the COGS and multiplying the result by 365 days, one may get the average age of Company A’s inventory. Divide $100,000 by $600,000 and multiply the result by 365 days. Company A’s inventory is 60.8 days old on average. This indicates that it takes the company around two months to sell its stock.
On the other hand, Company B had an inventory valued at $100,000 as well, but since it cost $1 million to sell, the average age of the inventory is just 36.5 days. Business B appears to be more productive than Company A.
- The average age of inventory indicates the average number of days a business takes to sell its stock.
- Days Sales in Inventory is another term for the average age of inventory.
- Other metrics, such as the gross profit margin, should be used to validate this number.
- A corporation might be more lucrative the quicker it can sell its inventory.
- An increasing number might indicate inventory problems for the firm.
