A lot of times when we use our inventory turnover ratio, we use a related ratio called the average days in inventory. Let's check it out here. So average days in inventory, remember it's going to be related to that inventory turnover ratio. Well, the average days in inventory, it helps us analyze how long a unit sits in the warehouse before being sold, okay? So this is literally going to be the number of days that we're thinking about that the unit sitting in the warehouse. So this average days in inventory, it's another common efficiency ratio similar to the inventory turnover ratio. Cool? So it's an efficiency ratio to see how efficiently we're using our inventory balance. So remember that holding inventory costs us money. So the longer that a unit sits in the warehouse, that's going to cost us money in renting the warehouse and paying utilities in the warehouse, whatever it is, there's going to be all sorts of expenses related to having inventory. So imagine the more and more inventory we have, the bigger warehouse we need, the more we're going to need to spend on it. So like I said, this average days in inventory, it's related to the inventory turnover and let's just go over that inventory turnover ratio real quick before we move on to the average days in inventory. Now there was a whole discussion on the inventory turnover ratio, so make sure that you understood that and then move on here with the average days in inventory. So remember, we calculated inventory turnover, we had the cost of goods sold divided by our average inventory, right? And we always calculate average balances in all cases, it's always going to be for any sort of average. Anytime we have an average, balance of an account, so average inventory, average accounts receivable, average whatever it is, we're going to take the beginning balance in that account plus the ending balance in that account and divide it by 2, right? Let me do it as a fraction here. Divided by 2, right? That's always going to be how we calculate average. So in this case, average inventory, beginning inventory plus ending inventory divided by 2. So notice when we go to calculate our average days in inventory, well all we do is we take our inventory turnover ratio and we're going to do 365 ratio , okay? So that's easy enough, right? And notice that this average days in inventory, just like it says, average days in inventory, it tells us how many days. How many days a unit sits in inventory. So it's going to be a number of days. This you on average, we buy a unit and it sits there for 20 days before we sell it, right? So you can imagine that a company wants to sell these things as fast as possible. They want a unit to come into inventory and we sell it right away to make that money. So how do we compare average days in inventory? Well, just like a lot of other ratios, we're going to use benchmarking, right? We want to compare to our industry. You can imagine different industries are going to have different days in inventory, right? Sometimes they're going to have to sit there for a while before they get sold. Sometimes things move really quickly. So we want to see how our competitors do in their average days in inventory as well as maybe just an industry average for this kind of number and then compare how our company is doing. Okay? So what do you think? Would a higher amount of days in inventory or a lower amount of days in inventory be more efficient? A lower amount of days, right? That's what we want. We want to be able to buy a unit and sell it immediately. We want a low amount of days in inventory and that means that we're turning our inventory really fast. So just like the inventory turnover, it's kind of related to it in a reciprocal fashion where we want to be able to turn over our inventory many times, well that means we're selling it quickly and we're going to have a low average days in inventory. So that's how these are kind of interrelated there. So why don't we move on to this example and see how we use the average days in inventory in practice. Let's try this example together. XYZ company had net sales of 500,000 and COGS of 320,000. If the beginning balance of inventory was 60,000 and the ending balance in inventory was 100,000, what is the average days in inventory? So the first thing we want to do is calculate our inventory turnover ratio, right? This is going to be a 2 step process. We calculate our inventory turnover ratio and then we do 365 divided by that ratio. So let's go ahead and do that. So remember, when we do our inventory turnover ratio, notice above we don't talk about net sales at all. That's extraneous information. We don't need that. So let's go ahead and use what we do need, our cogs for our numerator and our average inventory balance. So the first thing we want to do is that average inventory balance and remember, that's just beginning plus ending divided by 2. So what we got, 60000 + 100000 2 and that is going to be our average inventory. 160000 2 , 80,000 is our average inventory balance, right? So let's go ahead and finish up our inventory turnover ratio before we get to our average days in inventory. So inventory turnover, well, what do we got? 320000 80000 , right, cogs over average inventory and that gives us an inventory turnover ratio of 4.0. Right? 4 on the dot. So last thing we gotta do is calculate our average days in inventory. So here we go. How do we do it? Very simple, right? 365 4 . Well, we're going to round it. It's approximately 91. So remember, this is a number of days, right? This is a number of days, So what does that mean? We buy a unit into our inventory and it's going to sit there for 91 days, for 3 months before we sell it. Cool? So 91 days, that's our answer in this case. C is the answer. Alright. Cool. Let's go on to the next one and you guys try and calculate the average days in inventory.
Ratios: Average Days in Inventory - Online Tutor, Practice Problems & Exam Prep
Created using AIRatios: Average Days in Inventory
Video transcript
ABC Company had $200,000 in Net Sales and Gross Profit of $80,000. If Inventory had a balance of $60,000, what is the company's average days in inventory ratio?
Here’s what students ask on this topic:
What is the formula for calculating average days in inventory?
The formula for calculating average days in inventory is:
This formula helps determine the average number of days a unit remains in stock before being sold. A lower average indicates more efficient inventory management.
Created using AIHow do you calculate the inventory turnover ratio?
To calculate the inventory turnover ratio, use the following formula:
Where COGS is the cost of goods sold, and Average Inventory is calculated as:
Created using AIWhy is it important to compare average days in inventory to industry benchmarks?
Comparing average days in inventory to industry benchmarks is crucial because it helps assess a company's inventory management efficiency relative to its competitors. Different industries have varying norms for inventory turnover, so benchmarking provides context and helps identify areas for improvement. Efficient inventory management reduces holding costs and improves cash flow.
Created using AIWhat does a lower average days in inventory indicate?
A lower average days in inventory indicates that a company is efficiently managing its inventory. It means that units are sold quickly, reducing the costs associated with holding inventory, such as warehousing and utilities. This efficiency can lead to better cash flow and profitability.
Created using AIHow do you calculate average inventory?
To calculate average inventory, use the following formula:
This formula provides the average value of inventory over a specific period, which is essential for calculating the inventory turnover ratio.
Created using AI