Average Inventory Period Ratio tells the time period of the goods held in the inventory before sold. Simply we can say how much time a company has taken to sell its current inventory.
Or in other words how long inventory remains unsold and remains in the shelf. So it is said to be the efficiency ratio.
Definition: What is the Average Inventory Period?
From this ratio, it is easy to understand for the management that which products are sales fast and which sales slow.
From this ratio efficiency of the company find to converting goods into sales.
If the average inventory period is increasing it means that product takes much time to sell. but if the average inventory time is decreasing then product sales fastly and in less time.
For the management in the business monitoring of average inventory, the period is necessary. For the investor and analyst, it is also necessary to monitor this ratio.
Because of this ratio investor can find the ability of the company to turn its inventory into cash.
Average Inventory Period Ratio Formula
When we divide the number of days in the period by inventory turnover then we get average inventory period.
Average inventory period= num of days in periods/inventory turnover
Average turnover simply calculated by the sales divided by average inventory value. Whereas the number of days will be 1 year which we write in days as 365 days and divide by the inventory turnover.
To understand average inventory period in a better way we take the example here.
Average Inventory Period Ratio Example
Let we consider a rapidly growing company which is the company A. Analyst interest to calculate the average inventory period of this. then analyst comparison easily with other company of the same size.
For this purpose, the analyst needs the inventory turnover rate over last year. For this average beginning inventory and ending inventory is necessary which was $500,000 and $550,000.
To reveal the average inventory of 1 year $525,000 analyst divide sum of $1,050,000 by 2. In the end, he divides the cost of goods which was $5,000,000 by average inventory which was $525,000.
From this inventory turn calculated which was 9.5 then analyst put this value in the following equation.
38 days= 365 days/9.5 inventory turnover
So the average inventory period is 38 days. To see the progress of this company analyst compare this ratio result with the same other company.
Analysis and Interpretation
For a company, it is better to have a small average inventory period because it means that to convert the goods into cash company take a small time.
But if average inventory time is greater then it is not good for the company because for converting goods into cash take time.
For the direct competitor this ratio may be the same but for industries different average inventory period. If for the sales of good is time taken then the manager needs to calculate the average inventory time and then manage sales in a better way.
If some things of the company taken much time to sale then it increases the average inventory period of the company. The company need to manage these things to sales fast.
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