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Days sales in inventory (DSI) refers to a financial ratio showing the number of days a company takes to turn over all its inventory. All inventories are a summation of finished goods, work in progress, and progress payments. Days sales in inventory can also be called day’s inventory outstanding or the average age of an inventory.

Managers generally prefer lower days sales in inventory because it shows that the company is efficient in its operations and increases cash flow better within the company. On the other hand, a larger number of days or a higher days sales in inventory shows that the company has made a huge investment in the inventory and the possibility of goods being faced out in the market is very high. At the same time, a larger number of days increases the storage cost and exposes the stock to a risk of theft

Some goods are perishable and expire within a short duration making it necessary for a business to analyze approximately the average amount of time necessary to sell its inventory before they stock the shelves. This can only be realized with a deeper understanding of days sales in inventory ratio concept for managers to be able to assess the average amount of time for their companies to sell their inventory to decrease the chances of inventory getting obsolete and can cost the company money. Managers also must know when purchasing new inventory items is necessary to keep the business operating smoothly

Days Sales in Inventory Formula

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This formula has three different versions which can be used depending on what you’re looking for.

In the formula above, both beginning and closing inventories are summed up and then divided by two to give the average inventory value. Then the average found here is divided by the cost of goods sold to give days sales in inventory value “during” that particular period.

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In the formula above, the ending inventory figure is obtained from the balance sheet. Ending inventory can be from finished goods for a retail company. But for other companies that have even the work in process goods, all the accounts must be added up to get the exact ending inventory. The days sales in inventory value found here will represent DSI value “as of” the mentioned date.

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In the formula above, a new and related concept of inventory is introduced which is the number of times a company is able to it's stock over the course of a particular time period, say annually. To calculate inventory turnover you divide the cost of goods sold by the average inventory.

Note that the cost of goods sold does not change in all the three formulas and it is always the cost that was incurred in producing the goods sold. The days of sales in inventory use ending inventory whereas inventory turnover uses average inventory. Also, The number of days in a year is using 365 days but in some cases, you can be directed to use 360 which is widely accepted.

Days Sales in Inventory Example

Example 1

XYZ Limited is a leading retail corporation with an average inventory of $15 million. The cost of goods sold on their annual financial statements for 2018 was $300m. Assuming that the year ended in 365 days, determine XYZ Limited’s Days of Sales in Inventory.

For this, we use the average inventory formula:

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Now let’s break it down and identify the values of different variables in the problem.

  • Average Inventory = $15m
  • COGS = $300m

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Example 2

ABC Limited, a Microsoft Corp. recorded a total of $3 billion as ending inventory. The company spent a total of $40 billion to produce the goods that were sold in the fiscal year 2017. Since Microsoft manufactures both hardware and software products, by the end of the fiscal year 2017 the inventory was in different forms. Finished goods were worth $1.95 billion, work in progress was worth $385 million, and raw materials of around $665 million. Assuming that the fiscal year ended in 360 days, determine ABC Limited’s Days of Sales in Inventory.

For this, we use the ending inventory formula:

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Now let’s break it down and identify the values of different variables in the problem.

  • Ending Inventory = $3 billion
  • COGS = $40 billion

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ABC Limited takes 27 days to clear its inventory.

Days Sales in Inventory Analysis

From the examples above, the DSI concept is very simple and computing it takes the shortest time possible so long as one can identify the required variables from the problem. The three formulas above provide room for one easily compute DSI depending upon the accounting practice.

DSI concept is important in a company’s inventory management as it informs managers on the number of days the stock will last in the stores. Management, therefore, may find it beneficial to ensure that inventory moves fast to reduce costs and increase cash flows. The more time that the inventory remains on the shelves, the longer the company’s cash is held and cannot be used for other operations and hence costing the company extra money.

DSI values can be used to show the efficiency of the company in terms of its operations. For instance, when the DSI is low it means that the company is more efficient in its operations because it is taking the shortest time possible to clear its stock and restock again or use that money for other purposes within the company.

A lower DSI is also preferred because it ensures that the company reduces storage cost. By selling the whole stock within a short period for the case of foodstuff, consumers are guaranteed fresh and healthy. However, a high DSI could also mean that the company’s management maybe has decided to maintain high inventory levels to achieve high order fulfillment rates.

One key point to remember is that DSI figures often vary across different industries so it is advisable not to compare the performance of companies operating in different industries. Thus, DSI should only be used to compare the performance of companies within the same industry.

Days Sales in Inventory Conclusion

  • Days sales in inventory are the average number of days it takes for a firm to sell off inventory.
  • A high days sales in inventory suggests a company is poorly managing its inventory.
  • Days sales in inventory require two variables: Inventory (average or ending) Change and cost of goods sold.
  • Depending on the accounting practice, you can divide the average or ending inventory by the cost of goods sold.
  • Days sales in inventory are computed within a period of one year but can be adjusted depending on what you need.

Days Sales in Inventory Calculator

You can use the days sales in the inventory calculator below to quickly calculate the number of days a company needs to sell all its inventory by entering the required numbers.

 

 

FAQs

1. What is days sales in inventory ratio?

Days sales of inventory is a calculation used to measure the average number of days it takes a company to sell its inventory. All inventories, whether in the form of raw materials, work in progress, or finished goods, are considered.

2. How are days sales in inventory calculated?

DSI is calculated by dividing the average inventory by the cost of goods sold. The calculation is then multiplied by 365 to get the number of days.

The formula for days sales in inventory can be written as:

Days Sales in Inventory = Average Inventory / Cost of Goods Sold x 365 days

3. What is an example of a days sales in inventory calculation?

An example of a days sales in inventory calculation would be as follows:

Days Sales in Inventory = 15 / 300 x 365 days

This would result in a DSI of 18.5 days.

4. Why is the days sales in inventory important?

The days sales in inventory are important because it measures how quickly a company sells its inventory. A high DSI means that the company is selling its inventory slowly, which could be due to poor management or overstocking.

Another reason the days sales in inventory are important is that a high DSI can indicate that the company is losing money due to the costs associated with holding inventory (e.g. storage, insurance, etc.).

5. What is the difference between days sales in inventory ratio and days sales outstanding ratio?

The days sales outstanding (DSO) ratio measures the average number of days it takes a company to collect its receivables. The DSI ratio measures the average number of days it takes a company to sell its inventory.

Another difference between the two ratios is that the DSO ratio uses Accounts Receivable as its denominator, while the DSI ratio uses Cost of Goods Sold as its denominator."

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