What Is the Average Age of Inventory?
The average age of inventory is the average number of days it takes for a firm to sell off inventory. It is a metric that analysts use to determine the efficiency of sales. The average age of inventory is also referred to as days’ sales in inventory (DSI).
Formula and Calculation of Average Age of Inventory
The formula to calculate the average age of inventory is:
Average Age of Inventory=GC×365where:C=The average cost of inventory at its present levelG=The cost of goods sold (COGS)
- The average age of inventory tells how many days on average it takes a company to sell its inventory.
- The average age of inventory is also known as days’ sales in inventory.
- This metric should be confirmed with other figures, such as the gross profit margin.
- The faster a company can sell its inventory the more profitable it can be.
- A rising figure may suggest a company has inventory issues.
What the Average Age of Inventory Can Tell You
The average age of inventory tells the analyst how fast inventory is turning over at one company compared to another. The faster a company can sell inventory for a profit, the more profitable it is. However, a company could employ a strategy of maintaining higher levels of inventory for discounts or long-term planning efforts. While the metric can be used as a measure of efficiency, it should be confirmed with other measures of efficiency, such as gross profit marginbefore making any conclusions.
The average age of inventory is a critical figure in industries with rapid sales and product cycles, such as the technology industry. A high average age of inventory can indicate that a firm is not properly managing its inventory or that it has an inventory that is difficult to sell.
The average age of inventory helps purchasing agents make buying decisions and managers make pricing decisions, such as discounting existing inventory to move products and increase cash flow. As a firm’s average age of inventory increases, its exposure to obsolescence risk also grows. Obsolescence risk is the risk that the value of inventory loses its value over time or in a soft market. If a firm is unable to move inventory, it can take an inventory write-off for some amount less than the stated value on a firm’s balance sheet.
Example of How to Use the Average Age of Inventory
An investor decides to compare two retail companies. Company A owns inventory valued at $100,000 and the COGS is $600,000. The average age of Company A’s inventory is calculated by dividing the average cost of inventory by the COGS and then multiplying the product by 365 days. The calculation is $100,000 divided by $600,000, multiplied by 365 days. The average age of inventory for Company A is 60.8 days. That means it takes the firm approximately two months to sell its inventory.
Conversely, Company B also owns inventory valued at $100,000, but the cost of inventory sold is $1 million, which reduces the average age of inventory to 36.5 days. On the surface, Company B is more efficient than Company A.