![]() ![]() ![]() The management of Company A may want to consider decreasing prices of products or creating discounts and promotions to sell their inventory quicker. Therefore, Company B appears to be a more attractive investment. Given that the food retail industry can experience spoilage of products, it is more favorable to aim for a lower average age of inventory, so there is less chance that food products may become spoiled. It appears that Company B shows a much lower average age of inventory. Practical ExampleĪssume that you are an investor that is deciding on whether to invest in two food retail companies.Ĭompany A reports an average inventory of $200,000 and COGS of $1,000,000.Ĭompany B reports an average inventory of $100,000 and COGS of $1,500,000.Īssuming all other variables are equal, which company is a more attractive investment?Īverage Age of Inventory (Company A): ($200,000 / $1,000,000) x 365 = 73.0 daysĪverage Age of Inventory (Company B): ($100,000 / $1,500,000) x 365 = 24.3 days The management of companies who sell these products must pay close attention to their average age of inventory since if their inventory spoils, it is a complete write-off and can result in substantial losses. The product may need to be sold at a steep discount, perhaps even below its cost.Īs an example, the age of inventory is very important in the food industry – especially for perishable food items that can expire, such as fresh produce, meat, and dairy. Obsolescence risk essentially is the risk that a product or service may become obsolete and will not be able to be sold for expected market value. If the average age of inventory gets very high, then the inventory is exposed to obsolescence risk. However, if their average age of inventory is higher than other companies, then the company may be pricing its products too high, and therefore, is not selling products fast enough.Īdditionally, the average age of inventory can influence decisions on creating marketing strategies, such as offering discounts and promotions, selling aging inventory, and increasing cash flow. If their average age of inventory is lower than other companies, then the company may be pricing products too low. By monitoring the average age of inventory, managers can gain insight into what their pricing strategy should be. The average age of inventory is an important metric for managers to use as well. Inventory efficiency is an important metric for investors to evaluate for companies, especially if they operate in industries where inventory turnover is important. If a company reports a low inventory turnover (high average age of inventory), it can indicate that a company is not optimally managing its inventory or that its inventory is difficult to turn over. Inventory shortages represent lost sales and are extremely detrimental to a company’s profitability. However, if inventory turnover is too high, it can be a sign that the company is selling inventory too quickly and may experience inventory shortages. Generally, a faster inventory turnover (low average age of inventory) means that a company is efficiently selling inventory. The average age of inventory gives insight into how fast a company is turning over its inventory. Investors can use the average age of inventory to evaluate a company’s operations. Importance of the Average Age of Inventory From an Investor’s Perspective It includes direct raw materials and direct labor used to produce the goods. Cost of Goods Sold (COGS) – The direct costs associated with producing goods that are sold by a company.Average Inventory Balance – The average of the inventory balance at the beginning of the year and the inventory balance at the end of the year. ![]() The average age of inventory is calculated over a period of one year. The average age of inventory is calculated by taking the average inventory balance and dividing it by the cost of goods sold (COGS) for the period and then multiplying it by 365 days. How to Calculate the Average Age of Inventory It is an important working capital efficiency metric that is also referred to as days’ inventory on hand (DOH). The average age of inventory represents the average number of days that pass before a company sells its inventory balance. Updated JanuWhat is the Average Age of Inventory? ![]()
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