Average Age of Inventory
How old is your inventory on average?
The average age of inventory refers to how long it takes a company to sell out its inventory. It's a number that analysts use to figure out how efficient sales are. Days' sales in inventory is another term for the average age of inventory (DSI).
Average Inventory Age Formula and Calculation
The following is the formula for calculating the average age of inventory:
begin aligned &textAverage Age of Inventory= frac C G times 365 &text bfwhere: &C = &C = &C = &C = &C = &C = &C = &C = &C = &C = &C = &C = &C = &C = &C = &C = &C = &C = &C = &C = &C =
p&G = textThe cost of goods sold (COGS) & end aligned = textThe average cost of inventory at its current level
G C 365 is the average age of inventory, where:
C=current Inventory's average cost of goods sold.
G stands for the cost of products sold (COGS)
TAKEAWAYS IMPORTANT
The average age of inventory indicates how long it takes a corporation to sell its inventory on average.
Days' sales in inventory is another term for the average age of inventory.
Other data, such as the gross profit margin, should be used to corroborate this metric.
The more quickly a company's inventory can be sold, the more profitable it may be.
A growing figure might indicate that a corporation is experiencing inventory problems.
What Can the Average Inventory Age Tell You?
The average age of inventory indicates the analyst how quickly one company's inventory turns over in comparison to another. The more prosperous a corporation is, the faster it can sell merchandise for a profit. A corporation might, on the other hand, use a strategy of keeping larger quantities of inventory for discounts or long-term planning. While the statistic can be used as an efficiency indicator, it should be compared to other efficiency indicators, such as gross profit margin, before drawing any conclusions.
In sectors with fast sales and product cycles, such as technology, the average age of inventory is a crucial metric. A high average age of inventory may suggest that a company is not adequately managing its inventory or has difficult-to-sell goods.
Purchase agents and managers can use the average age of inventory to make purchasing choices and price decisions, such as lowering current inventory to sell items and enhance cash flow. As a company's average age of inventory rises, so does its risk of obsolescence. The risk of obsolescence occurs when the value of goods depreciates over time or in a weak market. If a company is unable to transfer goods, it might take an inventory write-off for a lesser amount than the balance sheet value.
An Example of How to Use Inventory's Average Age
An investor chooses to do a comparison between two retail businesses. Company A has $100,000 in inventory with a $600,000 cost of goods sold. Divide the average cost of inventory by the COGS, then multiply the product by 365 days to get the average age of Company A's inventory. $100,000 divided by $600,000 multiplied by 365 days equals $100,000 divided by $600,000. The average age of Company A's inventory is 60.8 days. That implies the company's inventory takes around two months to sell.
Company B, on the other hand, has $100,000 in inventory, but the cost of inventory sold is $1 million, bringing the average age of inventory down to 36.5 days. Company B appears to be more efficient than Company A on the surface.
