The average age of inventory indicates the average time period (in days) for which the inventory remains held by the firm before it is sold. It is calculated by dividing 365 days by the Inventory Turnover Ratio.

Reasons:

1. The Inventory Turnover Ratio determines how many times inventory is purchased or replaced during a year. Since it shows the frequency of conversion of inventory into revenue from operations, its reciprocal (when expressed in days) represents the average holding period.

2. It is a measure of liquidity. The average age of inventory helps assess how quickly the firm converts its stock into sales. A shorter holding period indicates efficient inventory management and better liquidity.

3. It helps identify potential issues. A high average age may indicate bad buying, obsolete inventory, or slow-moving stock, which serves as a danger signal for the business.