What is Days Sales Of Inventory - DSI
The days sales of inventory (DSI) is a financial ratio that indicates the average time (in days) that a company takes to turn its inventory (including goods that are a work in progress) into sales. It is also called as days inventory outstanding (DIO), days in inventory (DII) or, simply as days inventory, and is interpreted in multiple ways. Indicating the liquidity of the inventory, the figure represents how many days a company’s current stock of inventory will last. Generally, a lower DSI is preferred as it indicates a shorter duration to clear off the inventory though the average DSI varies from one industry to another.
Days Sales of Inventory
BREAKING DOWN Days Sales Of Inventory - DSI
Since DSI indicates the duration of the time a company’s cash is tied up in its inventory, a smaller value of DSI is preferred. A smaller number indicates that a company is more efficiently and frequently selling off its inventory which means rapid turnover leading to potential for higher profits (assuming that sales are being made in profit). On the other hand, a large DSI value indicates that the company may be struggling with obsolete, high-volume inventory and may have invested too much into the same. It is also possible that that the company may be retaining high inventory levels in order to achieve high order fulfillment rates, say in anticipation of bumper sales during an upcoming holiday season.
Formula to Calculate DSI
To manufacture a saleable product, a company needs raw material and other resources which forms the inventory and come at a cost. Additionally, there is a cost linked to the manufacturing of the saleable product using the inventory. Such costs include labor costs and payments towards utilities like electricity which is represented by the cost of goods sold (COGS), and is defined as the cost of acquiring or manufacturing the products that a company sells during a period. DSI is calculated based on the average value of the inventory and cost of goods sold during a given period or as of a particular date. Mathematically,
DSI = [ Average inventory / (Cost of Sales / Number of Days) ]
The number of days in the corresponding period is taken as 365 for a year and 90 for a quarter.
The numerator figure represents the valuation of the inventory. The denominator (Cost of Sales / Number of Days) represents the average per day cost being spent by the company for manufacturing a saleable product. The net factor gives the average number of days taken by the company to clear the inventory it possesses.
Two different versions of DSI formula are used depending upon the accounting practices. In the first version, the average inventory amount is taken as the figure reported at the end of the accounting period, like “at the end of fiscal year/quarter ending June 30.” This version represents DSI value “as of” the mentioned date. In another version, the average value of Start Date Inventory and End Date Inventory is taken, and the resulting figure represents DSI value “during” that particular period. Therefore,
Average Inventory = Ending Inventory, or
Average Inventory = (Beginning Inventory + Ending Inventory)/2
COGS value remains the same in both the versions.
Example of DSI Calculation
The leading retail corporation Walmart Inc. (WMT) had inventory worth $43.78 billion and cost of goods sold worth 373.4 billion for the fiscal year 2018. While inventory value is available in the balance sheet of the company, the COGS value can be sourced from the annual financial statement. Care should be taken to include the sum total of all the categories of inventory which includes Finished Goods, Work in Progress, Raw Materials, and Progress Payments & Other. Since Walmart is a retailer, it does not have any raw material, work in progress and progress payments. Its entire inventory comprises of finished goods. Taking the number of days as 365 for annual calculation, the DSI for Walmart comes to [43.78 / (373.4/365)] = 42.79 days.
Technology leader Microsoft Corp. (MSFT) had $2.66 billion as total inventory and $38.97 billion as COGS at the end of its fiscal year 2018. Since Microsoft is into creating software and hardware products, it has its inventory spread across Finished Goods ($1.95 billion), Work in Progress ($54 million) and Raw Materials ($655 million). Microsoft’s DSI value comes to [2.66 / (38.97/365)] = 24.91 days.
It indicates that Walmart had a longer period of around 43 days to clear its inventory, while Microsoft took around 25 days, on an average.
A look at similar figures for the online retail giant Amazon.com Inc. (AMZN), which had total inventory of $16.05 billion and COGS of $111.93 billion for the fiscal year 2017, reveals a relatively high value of 52.34 days. While both Walmart and Amazon are leading retailers, the mode of their operations explains the higher DSI value for the latter. Walmart gets a lot of footfall in its brick and mortar retail stores, and customers buy items in bulk as their purchases comprise of groceries which are perishable goods. On the other hand, Amazon customers purchase items selectively (often one or two at a time), and the delivery time may add to the DSI value. As Walmart cannot afford to retain perishable items in its inventory for long, it has a relatively lower DSI value compared to Amazon which sells a much diversified variety of goods that remain in its warehouses for a longer period.
Interpreting DSI Values
DSI is a measure of the effectiveness of inventory management by a company. Inventory forms a significant chunk of the operational capital requirements for a business. By calculating the number of days that a company holds onto the inventory before it is able to sell it off, this efficiency ratio measures the average length of time that a company’s cash is locked-up in the inventory.
However, the number should be looked upon cautiously as it often lacks context. As can be seen from the above examples of DSI values calculated for brick and mortar retail (Walmart), online retail (Amazon) and technology (Microsoft) sector companies, DSI tends to vary greatly among industries depending on various factors like product type and business model. Therefore, it is important to compare the value among same sector peer companies. Companies in the technology, automobile and furniture sectors can afford to hold on to their inventories for long, but those in the business of perishable or FMCG goods cannot. Therefore, sector-specific comparisons should be made for DSI values.
One must also note that a high DSI value may be preferred at times depending upon the market dynamics. If a short supply is expected for a particular product in the next quarter, a business may be better off in holding on to its inventory and then sell it later for a much higher price leading to improved profits in the long run. For example, a drought situation in a particular soft water region may mean that authorities will be forced to be supply water from another area where water quality is hard. It may lead to a surge in demand of water purifiers after certain period which may benefit the companies if they hold onto inventories.
Irrespective of the single-value figure indicated by DSI, the company management should find a mutually beneficial balance between optimal inventory levels and market demand.
Inventory Turnover - Another DSI-related Ratio
A similar ratio related to DSI is inventory turnover, which refers to the number of times a company is able to sell or use over the course of a particular time period such as a quarter or year. Mathematically,
Inventory Turnover = Cost of Goods Sold / Average Inventory
It is linked to DSI as
DSI = (1 / Inventory Turnover) x No. of Days
Basically, DSI is an inverse of inventory turnover over a given period. Higher DSI means lower turnover, and vice versa.
In general, the higher inventory turnover ratio, the better it is for the company, as it indicates a greater generation of sales. 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.
DSI is the first part of the three-part cash conversion cycle (CCC) which represents the overall process of turning raw materials into realizable cash from sales. The other two stages are days sales outstanding (DSO) and days payable outstanding (DPO). While the DSO ratio measures how long it takes a company to receive payment on accounts receivable, the DPO value measures how long it takes a company to pay off its accounts payable. Overall, the CCC value attempts to measure the average duration of time for which each net input dollar (cash) is tied up in the production and sales process before it gets converted into cash received through sales made to customers.
Why the Days Sales of Inventory Matters
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.
DSI and inventory turnover ratio can help investors whether a company can effectively manage its inventory when compared to competitors. A 2011 study published on the Social Science Research Network titled "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. 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.