Introduction
Inventory is the stock of products that a company has stored waiting to be sold. It can be raw materials, products in process (work in progress), or finished products.
Explanation
Inventory is necessary to operate (you can't sell without stock), but it is also expensive: it takes up space, it can become obsolete, it requires financing. The key is balance: too little inventory = lost sales; too much = tied up capital.
Formula
Inventory Turnover = Cost of Sales / Average Inventory
Days Inventory Outstanding (DIO) = 365 / Inventory Turnover
Example
Walmart vs Luxury Car: - Walmart: Inventory Turnover = 8× (inventory turns over every 45 days) - Luxury Car Dealer: Turnover = 2× (inventory rotates every 182 days) Walmart is much more efficient at moving inventory.
How to read it
High Inventory Turnover (8-12×) = efficient, low tied up capital. Low turnover (1-3×) = inventory moves slowly, risk of obsolescence. Red flag: inventory growing faster than sales = products are not selling or company is overproducing. Software/SaaS have ~0 inventory (huge advantage).
Key takeaways
- Inventory = products stored awaiting sale
- Necessary but expensive (immobilized capital)
- Inventory Turnover measures efficiency
- High turnover (8-12×) = efficient
- Inventory ↑ faster than sales = red flag
- Software has ~0 inventory (competitive advantage)