Days in inventory ratio measures how long goods stay in inventory, with high ratios leading to increased costs and low ratios potentially causing stock shortages. Accurate inventory records are essential for calculating the ratio.
Days in inventory is a ratio that people can use to determine, on average, how many days goods spend in inventory. Several different formulas can be used to find this relationship, depending on the approach a person wants to take. This, along with other sales metrics, can be used in inventory management and planning, allowing people to make decisions about stock and related matters based on hard numbers about the business.
If the days in inventory ratio is high, it means that the products are stored in inventory for a long time. The longer goods are kept in inventory, the more expensive they become, because the business will have to pay costs like overhead to maintain a storage facility, security, etc. Sometimes products move slowly because they are expensive or unusual, and a business may have several large ticket items on hand to make them available while trying to move a larger number of small items to make up for it. An appliance store, for example, might sell three appliances a week, but sell numerous accessories like new stovetop burners, appliance timers, etc.
High days in inventory ratio can turn into high overhead for the business. As long as the goods are not sold, the company cannot pay the sellers with the income and must pay the maintenance expenses. The business wants to avoid situations like this. Keeping too much on hand in general can eventually bankrupt a business, as creditors will become impatient with payments and the business will be unable to cover payroll and other basic expenses.
When the days-in-stock ratio is low, it means that products don’t stay on the shelf very long, and they move quickly through the store. While high turnover is usually a good thing, it can become a problem. A business may not have enough stock to meet demand, forcing customers to go elsewhere for their needs and causing customer frustration. The business needs to find a balance between overstocking and not having enough on hand for customers.
One way to determine days in inventory is to take the average daily inventory for a product, multiply it by 365, and then divide it by sales revenue. Keeping accurate inventory records is critical, otherwise the calculation may not be correct, and a small bias in the numbers can turn into a big mistake at the end of the equation.
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