How to use the days in inventory formula (with examples)
By Indeed Editorial Team
Published 22 April 2022
The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.
Days in inventory is a financial ratio that indicates how long it takes to turn a company's inventory into sales. Interpreting the ratio may differ, but typically, a lower ratio demonstrates a quicker turnaround time for the sale of stock. Knowing how to calculate the formula helps you understand the number of days current stock might last, which is useful when planning stock updates. In this article, we identify why the days in inventory formula is important, compare this formula with turnover ratio, discuss how to calculate and interpret it and provide examples of calculating days in inventory.
Why learn how to use the days in inventory formula?
The days in inventory formula can be an accurate indicator of whether a company can manage resources effectively compared to competitors. Unlike the turnover ratio, which reveals a company's efficiency in converting goods to sales, the days in inventory ratio also provide information about the number of days in which the company can make the conversion. In some sectors, a low ratio can suggest a surplus of stock, deficiencies in the market or poor inventory management. Such signs may help a sales team develop measures to improve the company's productivity.
Days in inventory vs turnover ratio
Turnover ratio is the number of times a company can use up its inventory within a duration of time, such as monthly or annually. It's possible to calculate a turnover ratio by dividing the value of merchandise sold by the average inventory. The turnover relates to the days in inventory formula through the following equation:
Days in inventory = (365 days) / (inventory turnover)
From the equation, you can conclude that the days in inventory formula is an inverse of the turnover ratio over a certain time period, such as a year. Higher days in inventory may indicate lower stock turnover. Typically, the higher the turnover, the more profitable the company, which demonstrates an increased sales lead generation. You can derive the days in inventory using the expression:
Days in inventory = (average inventory / cost of goods sold) × duration of time
You may choose days in inventory over inventory turnover when considering the number of days it takes to turn raw materials into funds. The turnover may be suitable when you choose to overlook time factors to concentrate on selling all the goods. When obtaining the number of days in inventory, it's helpful to gather the following details to use in the calculation:
duration: the number of days to cover in calculating the stock
average inventory: the number of items present in the stock
cost of goods sold: the amount the company requires to create the products
How to calculate days in inventory
You can use the following steps to calculate the days in inventory:
1. Select a duration
Decide the period you wish to calculate. For example, you may select March to June. You can then convert this duration into an exact number of days. The March to June period is the sum of the days in each month you are considering. Here, the days are:
(31 + 30 + 31 + 30) = 122 days
2. Calculate the average inventory
The next step is to determine the sum of the organisation's average stock. First, choose the duration you wish to consider. You can then determine the sum of the stock by adding the number of inventory units the firm has at the start of the selected period and the stock unit's value at the end of that period. Finally, you can find the average by dividing the sum by two.
For example, if a clothes shop starts the year with £10,000 and ends with an inventory of £5,000, you can calculate the shop's average inventory as (10,000 + 5,000) / 2. The answer gives you an average inventory of £7,500.
3. Determine the cost of goods sold
You can calculate the cost of goods a company has sold by adding the stock value at the beginning of the duration to the cost of acquiring the goods. Such expenses can include raw materials, labour, transport and other production demands. You may then subtract the inventory's value at the end of the time span you select.
For example, a clothes shop starts the year with £10,000 worth of inventory, ends with £5,000 and has a cost of goods worth £4,000. You can calculate the shops' cost of goods sold as (£10,000 + £4,000) − £5,000. The cost of goods sold is £9,000.
4. Find the inventory-to-cost ratio
The inventory-to-cost ratio depends on the cost of goods a marketer has sold and the average inventory. You can find it by taking the value of the average stock and dividing it by the price of goods they sell. Performing this step can complete the first part of the days in inventory calculation. For example, considering the clothes shop calculations from steps two and three above, the cost of goods is £9,000, while the average inventory is £7,500. You can express the ratio as 9,000 / 7,500. Simplifying, this gives a final ratio of 1.2.
5. Calculate the days in inventory
Using a company's inventory-to-cost ratio and selecting the duration, you can determine the days in inventory. This step involves selecting the stock-to-cost ratio and multiplying it by the length of time. It's important to calculate the period in days. For instance, a clothes shop may have an inventory-to-cost ratio of 1.2. If you consider the duration covers March to June, which is 122 days, you can express the days in inventory for the shop as 1.2 × 122 = 146.4.
Interpreting the days in inventory formula values
A smaller value of days in inventory may be preferable since the value indicates the length of time a company's inventory holds its funds. A small ratio can suggest that the company is selling its goods at a high rate. This may indicate that the company is making an increasing number of sales and has the potential to make higher profits. Significant inventory ratio days can also inform you when a company keeps its stock for too long. This situation may result from an enterprise investing more than necessary in their current stock or requiring an improvement in marketing skills.
A high value can also indicate that the firm is keeping large amounts of stock to fulfil future product orders, which they might expect to increase. For example, requests for children's toys may peak during the Christmas period. How you interpret the days in inventory value may vary depending on the industry. For instance, the same days in inventory value might offer unique insights for a car manufacturing company compared to those for a restaurant. Hence, the formula might be more useful when comparing companies in a similar sector.
Examples of calculating days in inventory
The following examples may help you better understand how to calculate days in inventory:
Healthy Food Supplier sells food refrigeration equipment. The company's average inventory is £20,000, while its cost of goods sold is £500,000. What are Healthy Food Supplier days in inventory for one year?
You can calculate this as:
(£20,000 / £500,000) × 365 = 14.6
The result is 14.6. This low inventory value may indicate that Healthy Food Supplier has high market sales and manages its inventory well.
Automobile repair shop
Crown Garage offers repair services to automobile owners and sells vehicle spare parts. It has an average inventory of £2,000 and a £75,000 cost of goods sold for one year. What are Crown Garage's days in inventory over a one-year period? You can calculate this as below:
(£2,000 / £75,000) × 365 = 9.7
The calculation gives an inventory value of 9.7 days. From this low result, you can conclude that Crown Garage manages its inventory efficiently.
Upside Flower Farm is a company that sells flowers to local hospitals and offices. Their annual average inventory is £10,000, while the cost of goods they sell has a value of £20,000. What are Upside Flower Farm's days in inventory for one year?
You can calculate this as below:
(£10,000 / £20,000) × 365 =182.5
This expression gives a value of 182.5 days. As this appears to be a high value for a flower farm, you may choose to inform the management team to improve the efficiency of its inventory operations.
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