What is 'Days Sales Of Inventory - DSI'
The days sales of inventory value, or DSI, is a financial measure of a company's performance that gives investors an idea of how long it takes a company to turn its inventory (including goods that are a work in progress, if applicable) into sales. Generally, a lower (shorter) DSI is preferred, but it is important to note that the average DSI varies from one industry to another.
Here is how the DSI is calculated:
The term days sales of inventory is also referred to as days inventory outstanding (DIO), days in inventory (DII) or, simply, days inventory.
BREAKING DOWN 'Days Sales Of Inventory - DSI'
Days sales of inventory, or days inventory, is one part of the cash conversion cycle, which represents the process of turning raw materials into cash. The days sales of inventory is the first stage in that process. The other two stages are days sales outstanding and days payable outstanding. The first measures how long it takes a company to receive payment on accounts receivable, while the second measures how long it takes a company to pay off its accounts payable.
To learn more about the cash conversion cycle, see Understanding the Cash Conversion Cycle.
DSI is one measure of inventory effectiveness. By calculating the number of days that a company holds onto inventory before selling, the efficiency ratio measures the average length of time that a company’s cash is tied up in inventory. The calculation gives further perspective to the overall inventory ratio by putting the figure into a daily context. The formula for DSI, equivalent to the average days to sell the inventory, is calculated as follows:
(Inventory / Cost of Sales) * 365
This metric taken on its own, however, lacks context. DSI tends to vary greatly between industries, depending on product type, business model, etc. Therefore, it is important to compare the value to that of other similar companies. For example, businesses that sell perishable or fast-moving products such as food items will have a lower DSI than those that sell non-perishable or slow-moving products such as cars or furniture.
As an example of the application of these important metrics, take Wal-Mart Stores, Inc. (WMT), which in 2014 reported annual sales of approximately $476 billion. Its year-end inventory equaled $44.9 billion, while its annual cost of sales was $358.1 billion. Thus, Wal-Mart’s inventory turnover for the year would be calculated as such:
$358.1 billion / $44.9 billion = 8
And the global retail giant’s DSI would be calculated accordingly, indicating that Wal-Mart sells its entire inventory within a quick 46-day period:
(1 / 8) * 365 = 46
The term inventory turnover refers to the number of times that inventory is sold or used over the course of a particular time period such as a quarter or year. A crucial metric for businesses, especially retailers of physical goods, the inventory turnover ratio measures a company’s efficiency in terms of management, inventory and generation of sales. As with a typical turnover ratio, inventory turnover calculates the amount of inventory that is sold over a period of time. As detailed in the Wal-Mart example, the formula for the inventory turnover ratio is as follows:
Cost of Goods Sold / Average Inventory
Sales / Inventory
In general, the higher inventory turnover ratio, the better it is for the company, as it indicates a greater generation of sales. In the same vein, a smaller inventory and the same amount of sales will also result in a high inventory turnover. In some cases, if the demand for a product outweighs the inventory on hand, a company will see a loss in sales despite the high turnover ratio, thus confirming the importance of contextualizing these figures by comparing them against those of industry competitors.
To learn more about the inventory turnover ratio, read the following FAQ: How Do I Calculate the Inventory Turnover Ratio? For more information on efficiency metrics, see the article on Measuring Company Efficiency.
Why It Matters
Metrics such as inventory ratio and days sales of inventory, specifically, can help inform investment decisions as they can indicate to an investor whether a company can effectively manage its inventory when compared to competitors. A 2013 study published on the Social Science Research Network and entitled Does Inventory Productivity Predict Future Stock Returns? A Retailing Industry Perspective suggests that stocks in companies with high inventory ratios tend to outperform industry averages. Such a stock that brings in a higher gross margin than predicted, can give investors an edge over competitors due to the potential surprise factor. Conversely, a low inventory ratio may suggest overstocking, market or product deficiencies or otherwise poorly managed inventory–signs that generally do not bode well for a company’s overall productivity and performance.
While these correlations seem intuitive, it is important to note possible exceptions. In some cases, a low inventory ratio may be preferred, for instance if inventory is increased in anticipation of a market shortage or a rapid price increase. If inventory is selling slowly, then a surplus is certainly not desirable. On the other hand, a shortage of inventory can lead to a higher ratio of turnover, though the company may experience a loss in sales. This is to say that it is important to find a mutually beneficial balance between optimal inventory levels and market demand.
For more information on the importance of inventory turnover and days sales of inventory, read the article What Does a High Inventory Turnover Tell Investors About a Company?
In summation, managing inventory levels is vital for most businesses, and it is especially important for retail companies or those selling physical goods. While the inventory turnover ratio is one of the best indicators of a company’s level of efficiency at turning over its inventory and generating sales from that inventory, the days sales of inventory ratio goes a step further by putting that figure into a daily context, and providing a more accurate picture of the company’s inventory management and overall efficiency.
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