How to calculate Days Sales of Inventory – formula | reason | documents and record
How to calculate Days Sales of Inventory
What is Days Sales in Inventory (DSI)?
Days sales in inventory, or DSI, indicates the average number of days that it takes a company to turn its inventory into sales. It is also known as the average age of inventory, days inventory outstanding, days in inventory, and several other similar names. The DSI is a financial ratio, and it can be interpreted as the number of days that the current stock of inventory will last for the company. Typically, a low DSI is preferable as it indicates a quick turnover of inventory, but the preferable DSI will vary based on the company and its industry.
Number of Days Sales in Inventory Formula
The number of days sales in inventory is the long-hand version of days sales in inventory. The DSI is calculated by dividing ending inventory by the cost of goods sold (COGS) and then multiplying by 365 days.
DSI = (Ending Inventory / Cost of Goods Sold) x 365
The ending inventory is located on the balance sheet and represents the balance in the inventory account at the end of the period. The cost of goods sold is found on the income statement and represents the cost of each item sold during the period. 365 days is in the formula to calculate the DSI for the entire year. This can be changed to a different number if DSI needs to be found for the week or the month.
High or Low Days Sales in Inventory
Days sales in inventory can be used to measure how efficiently a company can turn over its inventory. A lower DSI is preferable because it shows that its strategies are in line for quickly selling its inventory. A higher DSI means that a company is taking too long to sell its inventory and needs to revise its business model.
When interpreting DSI, it should be compared to the historic DSI of the company as well as its industry competitors. If DSI has decreased over time for a company, it could be due to changes in consumer demand, lack of technological advances, bad pricing strategies, or poor marketing.
Importance of Days Sales in Inventory
The number of days sales in inventory is an important metric for business and investors. This essential ratio shows how long a company has its cash sitting in inventory. Having inventory sit for a long amount of time is a poor use of money. Instead, that money could be utilized for business expenses else where.
Knowing DSI also helps managers decide when they need to buy new inventory and helps them decrease the chances of their inventory getting too old.
A smaller DSI shows continuous turnover of inventories, indicating a potentially higher level of sales and a higher profit. A high DSI could signal the company invested in too much inventory or their current product and sales strategies are not working. However, this number should always be taken into context of the season, company, and industry. For example, a toy store might have a higher DSI in the month leading up to Christmas as they prepare for a massive sales boost.
Another example is a car dealership. They might have a much slower moving inventory because of the large price tag and varied need for cars, resulting in a higher DSI. However, a grocery store should have a lower DSI since their products are perishable and must be rotated must quicker.
Example 1: How to Calculate Days Sales in Inventory?
The following example will illustrate how to calculate days sales in inventory:
Company A has an ending inventory of $45 million and COGS equal to $350 million. What is the DSI?
($45 / $350) * 365 = DSI
DSI = 46.93 days
In this example, Company A has a DSI of 46.93 days, which means that it takes nearly 47 days for the company to fully turnover its inventory stock. To analyze this further, it is necessary to know the context of the industry. For example, if Company A is a car dealership, this is a fantastic DSI. If Company A is a grocery store, this is terrible.
Example 2: Calculate Days Sales in Inventory
In this example, calculate days sales in inventory for fruit stand.
The ending inventory for the week is $50, and cost of goods sold is $200. Because DSI is being calculated for the week, multiply by 7 instead of 365.
DSI = ($50 / $200) * 7
DSI = 1.75 days
The fruit stand’s full inventory is turned over in less than 2 days. For this type of business this is a great DSI. As soon as the fruit is harvested and brought to be sold, it sells in less than two days. Since this is a great efficiency measure, there is no action to be taken. If DSI were much higher and unsustainable, such as 15 days, then action would need to be taken. The owner would need to produce less fruit, change up their marketing and sales strategies, check their pricing strategy, and/or change their location for a better chance at selling their fruit.
Days Sales in Inventory Ratio vs. Inventory Turnover
Days sales in inventory ratio, or DSI, is similar to the inventory turnover ratio, but there are key differences in these measures.
DSI shows how many days it takes for a company to sell its full inventory while the inventory turnover ratio shows the number of times a company sells its full inventory over a particular period. A lower DSI is desirable whereas the higher the inventory turnover, the better.
DSI is calculated by dividing ending inventory by cost of goods sold and multiplying by the days in the period being analyzed, inventory turnover is calculated by dividing the cost of goods sold by the average inventory. This change of COGS from the denominator in DSI to the numerator in inventory turnover is a key difference.
Both ratios show how well the company is managing its inventory stock as well as the efficiency of their sales and marketing strategies.
Lesson Summary
Days sales in inventory shows how long it takes a company to sell its full inventory stock within a certain period. It is calculated as follows: Days’ Sales of Inventory = (Ending Inventory / Cost of Goods Sold) x 365
Ending inventory can be found on the company’s balance sheet, and COGS can be found on the income statement. 365 represents the number of days in a year, which is the period that is typically analyzed. However, this can be changed to reflect a shorter or longer time period.
The days sales inventory, or DSI, is important for businesses to understand for several reasons. First, knowing DSI helps managers decide when they need to purchase more inventory to replenish their stock. Second, if their DSI is too high, they will want to make changes to their current strategies because having money tied up in sitting inventory is an inefficient use of funds. They want to sell the inventory so they can use the money for investments and expenses. Another reason they want a lower DSI is because they don’t want their inventory to be too old and become obsolete or unwanted.