What is the Average Age of Inventory?

The average age of inventory is the average period of time required for a business to sell off the inventory it currently has in stock. This measurement is commonly used to determine how well a business manages the amount of stock it has on hand. A short average age of inventory implies that a firm is doing a good job of restricting its investment in working capital.

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Understanding the Average Age of Inventory

The average age of inventory measurement reveals how fast a selling organization is turning over its inventory. Generally, faster turnover is good, since the business can generate high sales while investing in relatively modest amounts of inventory. Conversely, slower turnover likely means that there is some obsolete inventory in stock that may need to be written off. In addition, slower turnover implies that the business is investing more working capital for each sales dollar earned.

Fast inventory turnover may be essential in industries where product cycles are short, such as consumer electronics and high-fashion clothes. In these cases, a business must sell off its aging stock in short order, before it becomes completely obsolete. In these cases, the purchasing department will act quickly to unload aging inventory at a discount, resulting in a relatively short average age of inventory figure. If these goods cannot be sold off soon, they may be written off entirely and junked.

However, having a longer average age of inventory might be intentional. This is the case when a business is presenting customers with a wide range of options and a promise to always have products in stock, which results in a large inventory investment. In exchange, the business can set higher price points, resulting in higher margins.

In short, it is best to view the average age of inventory in conjunction with the profit margins being earned by a business.

This information is especially useful when compared to other businesses in the same industry, to see how well the organization is doing in relation to the competition.

How to Calculate the Average Age of Inventory

To calculate the average age of inventory, divide the average inventory for the year by the cost of goods sold for the same period, and then multiply by 365. For example, if a company has average inventory of $1 million and an annual cost of goods sold of $6 million, its average age of inventory is calculated as follows:

= ($1 million inventory ÷ $6 million cost of goods sold) x 365 days

= 60.8 days' sales in inventory

In this calculation, average inventory is usually calculated as the beginning inventory balance plus the ending inventory balance, divided by two. Another option that may be useful when the inventory balance changes dramatically over time is to calculate the ending inventory balance for every business day, and use the average of these values for the measurement period.