Days Sales in Inventory

Inventory activity ratios provide a measure of both the quality and the liquidity of the inventory on hand. Both quality and liquidity of inventory give an indication of the salability of the inventory.

The number of days’ sales in inventory is another measurement of the efficiency of inventory management. The days’ sales in inventory represents the average number of days that inventory items remain in stock before being sold, or the average number of days required to sell an item of inventory. The number of days’ sales in inventory should be low but not too low, because if it is too low, the company is risking lost sales because of not having enough inventory on hand.

Like days’ sales in receivables, the days’ sales in inventory can be calculated in several different ways:

Or, a variation on A, because to divide by a fraction, invert the fraction and multiply:

Or

All the ways of calculating days’ sales in inventory will yield the same answer. The method of calculating it is a matter of personal preference.

Like accounts receivable balances, year-end inventory balances may be distorted if a company is using a natural business year because its year-end inventory balances will be low. As with accounts receivable, calculating average inventory by averaging interim balances would be more accurate and would avoid the distortion resulting from simply averaging two (low) year-end balances.

The inventory activity ratios will be affected by the company’s choice of inventory valuation methods (LIFO, FIFO, etc.). Thus, they may not be useful for comparing companies when the companies use different inventory valuation methods.