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Question:

The average age of inventory is viewed as the average length of time inventory is held by the firm or as the average number of days’ sales in inventory. Why?

Answer:

Inventory Turnover Ratio: This ratio is a relationship between the cost of goods sold during a particular period of time and the cost of average inventory during a particular period. It is expressed in number of times. Stock turnover ratio/inventory turnover ratio indicates the number of time the stock has been turned over during the period and evaluates the efficiency with which a firm isable to manage its inventory. The formula for calculating inventory turnover ratio is as follows:

Inventory Turnover Ratio = Cost of goods sold
                                           Average Inventory at Cost

Cost of goods sold = Opening Stock + Purchase + Direct Expenses - Closing                                                                                                                          Stock
Alternatively cost of goods sold = Net Sales - Gross Profit
Average Inventory = Opening Stock + Closing Stock
                                                            2

From the above formula, it is clear that this ratio reveals the average length of
time for which the inventory is held by the firm.


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