The number of days it takes a company to sell its inventory goods is measured by inventory days on hand. It helps evaluate inventory efficiency since it enables you to optimize inventory levels to fulfill consumer demand, enhance cash flow, and cut down on expenses. Thus, adopting effective inventory management tips and tricks is crucial for maintaining healthy cash flow, minimizing storage costs, and ensuring customer satisfaction.
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What Are Inventory Days?
Inventory days are the average number of days a business holds its inventory before selling it. They are also referred to as days in inventory, days inventory outstanding, or days sales inventory. It determines inventory efficiency and liquidity by displaying how long funds are held in inventory.
What Are Inventory Days On Hand?
Inventory days on hand (also called ‘days of inventory on hand’) is a measure of how much time is needed for a business to exhaust a lot of inventory on average. By knowing the current and exact value of inventory days on hand, a business can reduce its ‘stockout days.’ The lower the number of inventory days on hand, the better it is for the company.
Inventory Days Formula
There are generally two main formulas used to calculate inventory days:
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Formula 1: Inventory Days = 365 days / Inventory Turnover Ratio
Here, the Inventory Turnover Ratio is the number of times inventory is sold and replaced in a year.
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Formula 2: Inventory Days = Average Inventory / Cost of Goods Sold (COGS) * Number of days in the period
Here, the Average Inventory is the average of the initial and closing inventory balances for the period.
Cost of Goods Sold (COGS) is the direct expenses related to the manufacturing of the items sold.
How To Calculate Inventory Days?
For example, suppose you want to calculate inventory days using an inventory turnover ratio of 4.32 per year. By using formula 1, the computation goes as follows:
Inventory Days = 365 days / Inventory Turnover Ratio= 365/4.32 = 84.49 days
If you performed the process with a different accounting period, such as a rotation of 2.31 over 180 days, then the average inventory days will be 77.92.
Now let’s suppose, you want to determine the average number of days inventory remains on hand before being sold.
For example, we have an:
Average Inventory of ₹6,00,000
COGS = ₹26,00,000
Therefore, by using formula 2,
Inventory days = (Average Inventory / COGS)* Number of days in the period
Inventory days = (₹6,00,000/ ₹26,00,000) * 365 days = 84.23 days
How To Calculate Inventory Turnover?
Inventory turnover = Cost of goods sold/Average inventory
Please note:
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COGS comprises direct sales costs such as expenditures, labor, and raw materials, but excludes general expenses such as rent
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Average inventory for the same period is used
For example, if your annual COGS is ₹32,000 and your average inventory value is ₹6,000, your inventory turnover is 5.33.
How To Calculate Average Inventory?
Average inventory helps estimate inventory turnover and days of inventory on hand. Here’s the formula:
Average Inventory = (Beginning inventory + Ending inventory) / 2
For example:
Beginning Inventory: ₹50,000
Ending Inventory: ₹40,000
Thus, the average inventory is (₹50,000 + ₹40,000)/ 2 = ₹45,000
Impact Of Inventory Days
High Inventory Days
Storing too much inventory can have various negative consequences:
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Increased carrying costs for storing and maintaining extra inventory
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Increased storage space needs to hold unused inventory
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Greater risk of product obsolescence or damage
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Reduced cash flow
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Lower profits from selling excess inventory at discounts
Low Inventory Days:
Insufficient inventory on hand can also lead to several issues:
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If demand outpaces supply, there might be stockouts and lost revenue
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Customer dissatisfaction because of delayed order fulfillment
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Missed profits and market share loss for competitors
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Production delays due to unavailability of necessary components or raw materials
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Increased prices for rapid shipment or emergency orders
How To Optimise For Inventory Days?
Implementing forecasting techniques to predict demand accurately:
You can optimize inventory by focusing on stocking high-demand products through accurate demand forecasting. Basic moving averages are very simplistic for today’s market shifts, which may result in over-forecasting and poor turnover. With statistical demand forecasting, it is important to account for the product’s life cycle, seasonal patterns, and market trends. Also, market volatility parameters should be adjusted, and qualitative inputs such as promotions and competition activities should be included.
Optimizing ordering quantities with methods like Economic Order Quantity (EOQ):
EOQ techniques can assist in determining the optimal order size while minimizing expenses associated with holding, ordering, and stockouts. EOQ calculates the most appropriate order quantity by accounting for demand, ordering expenses, and carrying costs.
Negotiating better lead times with suppliers:
Collaborate with suppliers to shorten lead times and optimize inventory levels. Shorter lead times allow businesses to order goods closer to when it is needed, minimising stocking requirements.
Utilizing inventory management software:
Inventory management software tracks inventory turnover, offers stock-level insights, and creates automated replenishment signals. This solution allows businesses to make data-driven decisions to optimize inventory days and minimize overstocking and stockouts.
Conclusion
Regularly analyzing inventory days allows you to measure performance and find areas for improvement. By assessing your inventory correctly and implementing proper management practices, you can significantly increase your business’s resilience in the face of unpredictable market changes.
Frequently Asked Questions (FAQs)
1. How many days of inventory on hand is good?
For most businesses, an inventory of 30 to 60 days is a very good target. Stockouts can result from having too little inventory, while capital constraints and higher storage costs might result from having too much. Lead times, storage capacity, and demand fluctuation are some of the variables that determine the ideal level.
2. Are days inventory on hand good or bad?
It is not a good idea to have too little inventory as it may result in stockouts and missed revenues. An adequate amount of inventory of 30 to 60 days is optimal.
3. What are the day’s sales in inventory?
Days sales in inventory (DSI) is a metric used to determine the time taken by a business to sell all of its inventory. A lower DSI signifies that the business is effectively turning inventory into sales. While the ideal DSI varies by sector, most businesses fall within the range of 30 to 60 days.
4. Can we have two inventories on the same day?
Although it is rare, a business can have two separate counts of inventory in one day. It can happen while doing a specific audit or switching to a new inventory management system. Usually, businesses only keep one up-to-date inventory record at any period.
5. How to decrease inventory days?
To reduce inventory days, businesses can enhance demand forecasts, optimize order volumes, and streamline supply chain procedures. Decreasing lead times and minimizing superfluous safety stock can also assist in reducing the number of days of inventory on hand. Regularly evaluating inventory levels and modifying buying is critical to maintaining an ideal inventory position.
6. How to calculate the inventory turnover ratio in days?
The inventory turnover ratio in days, commonly known as inventory on hand, is computed by dividing 365 days by the inventory turnover ratio. This calculates the average number of days it takes a business to sell its whole inventory.
7. What is inventory day in crude oil?
The average number of days’ worth of crude oil supply currently stockpiled is referred to as “crude oil inventory days.”
8. What does the day’s inventory outstanding mean?
Days inventory outstanding (DIO) estimates how many days, on average, a business keeps inventory before selling it. Since inventory is turned into sales more rapidly, a lower DIO denotes more effective inventory management.
