What is the average age of the inventory?
The average age of stocks is the average number of days it takes a business to sell its stocks. It is a measure that analysts use to determine sales effectiveness.
The average age of stocks is also called days of sales in stock (DSI).
What does the average age of stocks tell you?
The average age of stocks tells the analyst how quickly stocks turn around in one company compared to another. The faster a business can sell inventory for a profit, the more profitable it is. However, a business could use a strategy of maintaining higher inventory levels for discounts or long-term planning efforts. Although the metric can be used as a measure of efficiency, it must be confirmed by other measures of efficiency, such as gross profit margin, before drawing conclusions.
The average age of stocks is a critical number in industries with rapid sales and product cycles, such as the technology industry. A high average age of inventory may indicate that a business is not managing its inventory properly or that it has inventory that is difficult to sell.
The average age of inventory helps purchasing agents make purchasing decisions and managers make pricing decisions, such as refreshing existing inventory to move product and increase cash flow. As a company’s average inventory age increases, so does its exposure to the risk of obsolescence. The risk of obsolescence is the risk that the value of stocks will lose its value over time or in a weak market. If a business is unable to move inventory, it can write off inventory for an amount less than the value shown on a business’ balance sheet.
The formula for calculating the average age of the inventory is
TheAverage age of inventory=gVSThe×365or:VS=Average cost of inventory at its current levelg=Cost of goods sold (COGS)TheThe
Example of average inventory age
An investor decides to compare two retail companies. Company A has inventory valued at $ 100,000 and COGS at $ 600,000. The average age of company A’s stocks is calculated by dividing the average cost of stocks by the COGS, then multiplying the product by 365 days. The calculation is $ 100,000 divided by $ 600,000 multiplied by 365 days. The average age of stocks for company A is 60.8 days. This means that the company takes around two months to sell its stock.
Conversely, Company B also has 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.