Days Sales in Inventory
Days’ sales in inventory (DSI) is an efficiency ratio that tells you about the average number of days that are required for a business to convert its inventory into sales during the course of an accounting period. There is no benchmark figure for this ratio as it varies from industry to industry.
This ratio is also known as days’ inventory outstanding, days’ inventory or days’ in inventory and is interpreted in a number of different ways. Indicating the liquidity of an entity’s inventory, the DSI represents as to how many days an entity’s will take to sell its inventory. Usually, businesses prefer a lower DSI as it indicates a shorter time period for clearing inventory. However, the average DSI varies depending on the industry in which an entity is operating.
The formula used for calculation of day’s sales in inventory is as follows:
Day’s Sales in Inventory= (Closing Inventory/ COGS for the period) x Number of days in the period
Average inventory can also be used instead of closing inventory in the aforementioned formula.
The formula for calculating average inventory is as follows:
Average Inventory= (Beginning inventory + Closing Inventory)/2
What Does DSI Tell?
DSI basically indicates the time duration for which an entity’s cash is locked up in its stock. Businesses prefer lower DSI as it indicates that the business is efficient in its operations while a higher DSI indicates that an entity may be struggling with high-volume inventory due to investing heavily into the same. Another reason for a higher DSI may be an entity retaining high levels of inventory in order to fulfil large order volumes.
In simple words, it is a ratio that is used for measuring and assessing as to how effectively an entity is managing its inventory by determining the days for which an entity’s cash is tied up in the inventory.
DSI & Inventory Turnover
A ratio that is pretty similar to DSI is inventory turnover. This ratio indicates the number of times an entity was able to use or sell its inventory during the course of a specific financial period. The formula for calculating Inventory/ stock turnover is as follows:
Inventory Turnover = COGS/ Average inventory
The inventory/ stock turnover ratio is linked to Days’ Sales in Inventory ratio via the below mentioned relationship:
DSI = 1/inventory turnover x Number of days in the period
Importance of DSI
Managing levels of inventory is very important for most entities, and it is especially integral for retail businesses or those that are selling physical items. While, the inventory/ stock turnover ratio is mostly used for assessing an entity’s efficiency and effectiveness in generating sales and turning over its inventory, the DSI ratio goes one step ahead by putting that figure into a daily context and providing more accurate information about an entity’s inventory management as well as its overall efficiency and effectiveness.
Example: A Company reported closing inventory of $15M and a cost of sales of $120M in its financial statements for the financial year ended December 31, 2018. Given the figures, the days’ sales in inventory or inventory days for the financial year ended December 31, 2018 is 45.63 days, meaning it takes 46 days for the corporation to sell its entire inventory.