Days’ Sales in Inventory
Days’ Sales in Inventory (DSI), also known as Days Inventory Outstanding (DIO), is a financial ratio that measures the average number of days a company holds its inventory before selling it. It’s a measure of the efficiency of a company’s inventory management.
The formula for DSI is as follows:
\(\text{Days’ Sales in Inventory} = \frac{\text{Average Inventory}}{\text{Cost of Goods Sold}} \times 365 \)
Where:
- “Average Inventory” is the average amount of inventory the company held during the time period. It can be calculated as (Beginning Inventory + Ending Inventory) / 2 if the inventory level has significantly fluctuated within the period.
- Cost of Goods Sold” (COGS) refers to the direct costs of producing the goods sold by a company. This includes the cost of the materials and labor directly used to create the good.
The result tells you, on average, how many days it takes for a company to turn its inventory into sales.
A lower DSI is generally better because it indicates that the company quickly turns over its inventory, which can suggest good inventory management and high demand for its products. However, a DSI that’s too low might mean the company is at risk of running out of inventory and not being able to meet demand.
A higher DSI, on the other hand, indicates that the company holds onto its inventory for a longer period before selling it. This could suggest excess inventory, low demand for the company’s products, or inefficiencies in the production or sales processes.
As with other financial ratios, DSI should be compared with industry averages and the company’s historical performance to provide meaningful insights.
Example of Days’ Sales in Inventory
Let’s consider a hypothetical company that manufactures sporting goods.
Suppose for the current fiscal year, the company reported:
- Beginning inventory: $500,000
- Ending inventory: $600,000
- Cost of Goods Sold (COGS): $2,200,000
First, we calculate the average inventory for the year:
Average Inventory = (Beginning Inventory + Ending Inventory) / 2 Average Inventory = ($500,000 + $600,000) / 2 = $550,000
Now, we can calculate the Days’ Sales in Inventory (DSI):
\(\text{DSI} = \frac{\text{Average Inventory}}{\text{COGS}} \times 365 \)
\(\text{DSI} = \frac{\$550,000}{\$2,200,000} \times 365 = \text{approximately 91.3 days} \)
This means that, on average, it takes the company about 91 days to turn its inventory into sales.
To interpret this DSI, the company would need to compare it with its own DSI from previous years, as well as with the DSIs of other companies in the same industry.
For example, if the industry average DSI is 80 days, the company might be taking longer than its competitors to sell its inventory, which could indicate overstocking or issues with product demand. On the other hand, if the company’s DSI was 100 days the previous year, the current DSI of 91 days could indicate an improvement in inventory management.
