What is the Inventory Days Ratio?
The inventory days ratio or days in inventory ratio shows the average number of days sales a business is holding in its inventory. It is calculated by dividing inventory by average daily cost of goods sold. It is sometimes called the stock days ratio.
What is the formula for Inventory Days Ratio?
- Inventory is the average of the opening and closing inventory given in the balance sheet and is normally under the heading inventory or stock.
- Cost of goods sold is found in the income statement.
How is the Inventory Days Ratio calculated in practice?
|Cost of goods sold||176,000|
|Earnings before tax||44,000|
|Long term debt||190,000|
|Total liabilities and equity||540,000|
In the example above the cost of goods sold is 176,000 and ending inventory is 20,000. As the opening inventory is not available, the ending inventory is used, and the inventory days is calculated as follows:
Inventory days = Inventory / (Cost of goods sold / 365) Inventory days = 20,000 / (176,000 / 365) = 41 days
The business on average is holding 41 days of sales in its inventory.
This in theory means that if production or supplies stopped then the business would run out of inventory after 41 days. In practice it is unlikely that demand would exactly match the items in inventory.
If you are using cost of goods sold for a different period then replace the 365 with the number of days in the management accounting period.
For example, if using monthly (30 days) management accounts
Monthly cost of goods sold 14,000 and month end inventory 15,000 then
Inventory Days Ratio = 15,000 / (14,000 / 30) = 32 days
What does the Days in Inventory Ratio show?
If your days in inventory are increasing it indicates that the business is building up inventory and an increasing amount of cash (possibly overdrafts) is being tied up.
Any downward trend in the inventory days ratio means that inventory levels are being kept under control in relation to the level of sales. However, care must be taken not to let the inventory days ratio fall too low as this may eventually result in inventory shortages as demand fluctuates.
Useful tips for Inventory Turnover Days Interpretation
- The days of inventory on hand will vary from industry to industry. To make comparisons you need to use a comparable business operating in your sector.
- The days in inventory should be a low as possible without causing inventory shortages. It is generally accepted that money tied up in inventory earns very little or nothing for the business.
- Typical ranges for the days in inventory ratio would be 30-60 days.
Relationship to Inventory Turnover Ratio
The inventory days calculation is linked to the inventory turnover ratio by the following formula.