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 inventories. It is calculated by dividing inventories by the average daily cost of goods sold. It is sometimes called the stock days ratio.
Inventory Days Formula
The inventory days is calculated using the following formula.
- Inventory is the average of the opening and closing inventories 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 inventories are 20,000. As the opening inventories are not available, the ending inventories are 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 inventories.
This in theory means that if production or supplies stopped then the business would run out of inventories after 41 days. In practice it is unlikely that demand would exactly match the items in inventories.
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 inventories are 15,000 then
Inventory Days Ratio = 15,000 / (14,000 / 30) = 32 days
What does the Days in Inventory Ratio show?
Inventory days is a measure of the efficiency of the inventories policy of the business. Consequently 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.
In contrast any downward trend in the 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 ratio fall too low as this may eventually result in inventories shortages as demand fluctuates.
- 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 shortages. It is generally accepted that money tied up in inventories earns very little or nothing for the business.
- Typical ranges for the days in inventory ratio would be 30-60 days.
Relationship to the Inventories Turnover Ratio
The inventory days calculation is linked to the inventory turnover ratio by the following formula.
About the Author
Chartered accountant Michael Brown is the founder and CEO of Double Entry Bookkeeping. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a degree from Loughborough University.