Inventory is often the largest current asset on a trading or manufacturing company’s balance sheet, and it is cash sitting on shelves. Lenders look closely at how fast it turns into sales, because slow stock ties up working capital and can hide obsolete or unsaleable goods.
The formulas
Inventory turnover = Cost of goods sold ÷ Average inventory
Days inventory outstanding (DIO) = 365 ÷ Inventory turnover
or equivalently, DIO = (Average inventory ÷ Cost of goods sold) × 365.
Average inventory is usually (opening inventory + closing inventory) ÷ 2. Using cost of goods sold rather than sales keeps both figures at cost, which gives a cleaner measure.
Worked example
A distributor reports:
- Cost of goods sold: 48,000,000
- Opening inventory: 9,000,000
- Closing inventory: 11,000,000
- Average inventory = (9,000,000 + 11,000,000) ÷ 2 = 10,000,000
- Inventory turnover = 48,000,000 ÷ 10,000,000 = 4.8 times
- DIO = 365 ÷ 4.8 = 76 days
On average, stock sits for about 76 days before it is sold.
What is a good figure?
There is no universal benchmark. Grocery and fresh-food businesses may turn stock every couple of weeks, while machinery dealers or jewellers may hold stock for many months. What matters most to a lender is:
- The trend. DIO rising from 60 to 90 days over two years is a warning sign even if 90 days is normal for the sector.
- Comparison with peers in the same industry.
- Consistency with the business story. A planned stock build-up before a peak season is different from unplanned slow sales.
Why lenders care
Working capital needs
Every extra day of inventory needs financing. If the distributor above increased DIO from 76 to 90 days, its average inventory would rise by about 14 days × (48,000,000 ÷ 365) ≈ 1.84 million. That is cash that must come from profits, suppliers or the bank.
Quality of stock
Slow-moving items may be obsolete, damaged or out of fashion. Lenders may apply a lower advance rate to inventory in a borrowing base, or exclude ageing stock entirely.
Cash conversion cycle
DIO is one part of the cash conversion cycle: DIO + days sales outstanding − days payables outstanding. A long cycle means the business funds more of its operations before customers pay. Try the cash conversion cycle calculator or read the working capital cycle explained.
Common mistakes
- Using sales instead of cost of goods sold, which overstates turnover.
- Using only closing inventory in a seasonal business, which can distort the result.
- Ignoring stock write-downs. If inventory is reported at cost but some items can only be sold at a loss, the real position is weaker than it looks.
How to improve inventory turnover
- Review slow-moving items monthly and clear them before they become obsolete.
- Order closer to demand, using sales data rather than habit.
- Negotiate smaller, more frequent deliveries with suppliers.
- Focus on fast-moving, higher-margin product lines.
Lenders will also look at your liquidity ratios. See current ratio vs quick ratio and the financial ratios banks use, and estimate your funding needs with the working capital calculator.
Inventory days by industry
Days inventory varies widely by sector. These broad ranges help you see where your business stands:
| Type of business | Typical days inventory |
|---|---|
| Fresh food and grocery retail | 10 – 30 days |
| Fashion and general retail | 60 – 120 days |
| Wholesale and distribution | 30 – 75 days |
| Manufacturing (raw material + work in progress + finished goods) | 60 – 150 days |
| Pharmaceuticals and spare parts | 90 – 180 days |
What matters most to a lender is your own trend. Inventory days rising from 60 to 90 over two years ties up cash and raises questions about slow-moving or obsolete stock.
How inventory affects how much a bank will lend
For working-capital lines, banks rarely lend against the full value of stock. They calculate a drawing power:
- Start with the value of eligible stock (at cost or market value, whichever is lower).
- Exclude obsolete, damaged or slow-moving items.
- Apply a margin, often 20–40% depending on the type of stock.
Example: A distributor holds stock worth 30,000,000. The bank excludes 2,000,000 of slow-moving items and applies a 25% margin. Drawing power is (30,000,000 − 2,000,000) × 75% = 21,000,000.
The lower your inventory days, the more of your stock counts as eligible, and the less you need to borrow in the first place.
Inventory in Islamic finance
In Islamic financing, stock is often funded through Murabaha (the bank buys the goods and sells them to you on deferred payment) or Running Musharakah. The bank will still look closely at stock reports, because the transaction has to be tied to real goods. See which Islamic financing mode fits which business need.
From the credit desk
What we look for when this comes up in a real credit file:
- We cross-check stock in the balance sheet against stock statements submitted to the bank. Large differences between the two raise questions about both.
- Slow-moving and obsolete stock is usually excluded or given a heavy margin when drawing power is calculated, so it supports far less borrowing than its book value suggests.
- Rising inventory days alongside flat sales usually means stock is building up unsold. Analysts will ask why before they increase any working capital limit.
Worked example: Cost of sales of PKR 90 million and average inventory of PKR 22.5 million give inventory turnover of 4 times, or about 91 days. If peers turn stock in 60 days, expect the bank to ask why.
Frequently asked questions
Is a high inventory turnover always good?
Usually, but not always. Very high turnover can mean you are running too lean and losing sales because items are out of stock.
Should I use cost of goods sold or sales in the formula?
Use cost of goods sold. Stock is recorded at cost, so dividing it by sales (which include your margin) overstates turnover.
How often should I calculate it?
Monthly or quarterly is ideal. A single annual figure can hide seasonal build-ups, which lenders often ask about.
Where does inventory fit in the bigger picture?
Inventory days are one part of the cash conversion cycle, together with debtor days and creditor days.
Sources and further reading
- IFRS Foundation: IAS 2 Inventories
- State Bank of Pakistan: Laws and Regulations (Prudential Regulations)
Related guides
- Debtor Days Explained: How Banks Read Your Receivables
- The Working Capital Cycle, Explained: How Much Cash Your Business Really Ties Up
- Current Ratio vs Quick Ratio: Formulas, Example and How Lenders Read Them
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