What is Days Sales in Inventory?
Days Sales in Inventory (DSI) calculates the number of days it takes a company on average to convert its inventory into revenue.
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How to Calculate Days Sales in Inventory (Step-by-Step)
Days sales in inventory (DSI) measure how much time is necessary for a company to turn its inventory into sales.
The inventory line item on the balance sheet captures the dollar value of the following:
- Raw Materials
- Work-in-Progress (WIP)
- Finished Goods
The fewer days required for inventory to convert into sales, the more efficient the company is.
- Short DSI → A shorter DSI suggests that the company’s current strategy for customer acquisitions, sales and marketing, and product pricing is effective.
- Long DSI → The reverse is true for a long DSI, which could be a potential sign that the company should adjust its business model and spend more time researching its target customer (and their spending patterns).
Days Sales in Inventory Formula
Calculating a company’s days sales in inventory (DSI) consists of first dividing its average inventory balance by COGS.
Next, the resulting figure is multiplied by 365 days to arrive at DSI.
For example, let’s say that a company’s DSI is 50 days.
A 50-day DSI means that on average, the company needs 50 days to clear out its inventory on hand.
Alternatively, another method to calculate DSI is to divide 365 days by the inventory turnover ratio.
How to Interpret DSI Ratio (High vs. Low)
Comparing a company’s DSI relative to that of comparable companies can offer useful insights into the company’s inventory management.
While the average DSI depends on the industry, a lower DSI is viewed more positively in most cases.
If a company’s DSI is on the lower end, it is converting inventory into sales more quickly than its peers.
Moreover, a low DSI indicates that purchases of inventory and the management of orders have been executed efficiently.
Companies attempt to minimize their DSI in an effort to limit the time that inventory is sitting around waiting to be sold.
Common issues that can cause a company’s DSI to increase are the following:
- Lack of Consumer Demand
- Trailing Behind Competitors
- Pricing is Excessive
- Mismatch with Target Customer
- Poor Marketing
How Change in Inventory Impacts Free Cash Flow (FCF)
- Increase in Inventory: In terms of the cash flow impact, an increase in a working capital asset such as inventory represents an outflow of cash (and a decrease in inventory would represent a cash inflow). If a company’s inventory balance has increased, more cash is tied up within operations, i.e. it is taking more time for the company to produce and sell its inventory.
- Decrease in Inventory: On the other hand, if a company’s inventory balance were to reduce, there would be more free cash flow (FCF) available for reinvestments or other discretionary spending needs such as growth capital expenditures (capex). In short, the company requires less time to sell off its inventory on hand and is thereby more efficient operationally.
Days Sales in Inventory Calculation Example
Suppose a company’s current cost of goods sold (COGS) is $80 million.
If the company’s inventory balance in the current period is $12 million and the prior year’s balance is $8 million, the average inventory balance is $10 million.
- Year 1 COGS = $80 million
- Year 0 Inventory = $8 million
- Year 1 Inventory = $12 million
Using those assumptions, DSI can be calculated by dividing the average inventory balance by COGS and then multiplying by 365 days.
- Days Sales in Inventory (DSI) = ($10 million / $80 million) * 365 Days
- DSI = 46 Days