Days' sales in inventory (DSI) is a way to measure the average time required for a company to convert its inventory into sales. A small number of days' sales in inventory indicates that a company is more efficient at selling off its inventory, while a large number indicates that it may have invested too much in inventory, and may even have obsolete inventory on hand. However, a large number may also mean that management has decided to maintain high inventory levels in order to achieve high order fulfillment rates.
The days' sales in inventory figure is intended for the use of an outside financial analyst who is using ratio analysis to estimate the performance of a company. The metric is less commonly used within a business, since employees can access detailed reports that reveal exactly which inventory items are selling better or worse than average.
To calculate days' sales in inventory, divide the average inventory for the year by the cost of goods sold for the same period, and then multiply by 365. For example, if a company has average inventory of $1 million and an annual cost of goods sold of $6 million, its days' sales in inventory is calculated as:
= ($1 million inventory ÷ $6 million cost of goods sold) x 365 days
= 60.8 days' sales in inventory
The days' sales in inventory figure can be misleading, for the following reasons:
- Large adjustments. A company could post financial results that indicate low days in inventory, but only because it has sold off a large amount of inventory at a discount, or has written off some inventory as obsolete. An indicator of these actions is when profits decline at the same time that the number of days sales in inventory declines.
- Aggregations. The inventory figure used in the calculation is for the aggregate amount of inventory on hand, and so will mask small clusters of inventory that may be selling quite slowly (if at all).
- Calculation change. A company may change its method for calculating the cost of goods sold, such as by capitalizing more or fewer expenses into overhead. If this calculation method varies significantly from the method the company used in the past, it can lead to a sudden alteration in the results of the measurement.
- Ending balance used. You could use the amount of ending inventory in the numerator, rather than the average inventory figure for the entire measurement period. If the ending inventory figure varies significantly from the average inventory figure, this can result in a sharp change in the measurement.
- Outsourced production. A company may switch to contract manufacturing, where a supplier produces and holds goods on behalf of the company. Depending upon the arrangement, the company may have no inventory to report at all, which renders the DSI useless.
- Profitability. A business may reduce its prices in order to more rapidly sell off inventory. Doing so certainly improves the sales to inventory ratio, but harms overall profitability.
The days' sales in inventory figure can vary considerably by industry, so do not use it to compare the performance of companies located in different industries. Instead, only use it to compare the performance of companies with their peers in the same industry.
The measure can be used in concert with the days of sales outstanding and days of payables outstanding measures to determine the short-term cash flow health of a business.
Days' sales in inventory is also known as days in inventory, days of inventory, the sales to inventory ratio, and inventory days on hand.