Days Sales of Inventory – DSI

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.

DSI is also known as the average age of inventory, days inventory outstanding (DIO), days in inventory (DII), days sales in inventory or 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.

Formula and Calculating DSI

D S I = Average inventory C O G S × 3 6 5  days where: D S I = days sales of inventory C O G S = cost of goods sold \begin{aligned} &DSI = \frac{\text{Average inventory}}{COGS} \times 365 \text{ days}\\ &\textbf{where:}\\ &DSI=\text{days sales of inventory}\\ &COGS=\text{cost of goods sold}\\ \end{aligned} DSI=COGSAverage inventory×365 dayswhere:DSI=days sales of inventoryCOGS=cost of goods sold

To manufacture a salable product, a company needs raw material and other resources which form the inventory and come at a cost. Additionally, there is a cost linked to the manufacturing of the salable 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, the number of days in the corresponding period is calculated using 365 for a year and 90 for a quarter. In some cases, 360 days is used instead.

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 salable product. The net factor gives the average number of days taken by the company to clear the inventory it possesses.

Two different versions of the DSI formula can be 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, such as at the end of the fiscal year 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 \text{Average Inventory} = \text{Ending Inventory} Average Inventory=Ending Inventory

Average Inventory = ( Beginning Inventory + Ending Inventory ) 2 \text{Average Inventory} = \frac{(\text{Beginning Inventory} + \text{Ending Inventory})}{2} Average Inventory=2(Beginning Inventory+Ending Inventory)

COGS value remains the same in both the versions.

What DSI Tells You

Since DSI indicates the duration of 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 the 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 the company may be retaining high inventory levels in order to achieve high order fulfillment rates, such as in anticipation of bumper sales during an upcoming holiday season.

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, this efficiency ratio measures the average length of time that a company’s cash is locked up in the inventory.

However, this number should be looked upon cautiously as it often lacks context. 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 the 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 fast moving consumer goods (FMCG) 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 on the market dynamics. If a short supply is expected for a particular product in the next quarter, a business may be better off holding on to its inventory and then selling it later for a much higher price, thus 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 supply water from another area where water quality is hard. It may lead to a surge in demand for water purifiers after a 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.

DSI vs. Inventory Turnover

A similar ratio related to DSI is inventory turnover, which refers to the number of times a company is able to sell or use its inventory over the course of a particular time period, such as quarterly or annually. Inventory turnover is calculated as the cost of goods sold divided by average inventory. It is linked to DSI via the following relationship:

D S I = 1 inventory turnover × 3 6 5  days DSI = \frac{1}{\text{inventory turnover}}\times 365 \text{ days} DSI=inventory turnover1×365 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 the 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 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 DSI 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 to know whether a company can effectively manage its inventory when compared to competitors. A 2014 paper in Management Science, "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.

Example of DSI

The leading retail corporation Walmart (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. Since Walmart is a retailer, it does not have any raw material, work in progress and progress payments. Its entire inventory is comprised of finished goods. Using 365 as the number of days for the annual calculation, the DSI for Walmart is

[ 4 3 . 7 8 ( 3 7 3 . 4 / 3 6 5 ) ] = 4 2 . 7 9  days [\frac{43.78} {(373.4/365)}] = 42.79 \text{ days} [(373.4/365)43.78]=42.79 days

Technology leader Microsoft (MSFT) had $2.66 billion as total inventory and $38.35 billion as COGS at the end of its fiscal year 2018. Since Microsoft creates 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 is:

[ 2 . 6 6 ( 3 8 . 9 7 / 3 6 5 ) ] = 2 4 . 9 1  days [\frac{2.66} {(38.97/365)}] = 24.91 \text{ days} [(38.97/365)2.66]=24.91 days

These figures indicate that Walmart had a longer period of around 43 days to clear its inventory, while Microsoft took around 25 days.

A look at similar figures for the online retail giant Amazon (AMZN), which had a total inventory of $17.17 billion and COGS of $139.16 billion for the fiscal year 2018, reveals a relatively high value of 45.03 days. While both Walmart and Amazon are leading retailers, the mode of their operations explains the higher DSI value for the latter. Walmart sees a lot of foot traffic in its brick and mortar retail stores, and customers buy items in bulk as their purchases are comprised 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 very diversified variety of goods that remain in its warehouses for a longer period.