What is days' sales in inventory?

Days' sales in inventory (DSI) is a way to measure the average amount of time that it takes for a company to convert its inventory into sales. A relatively small number of days' sales in inventory indicates that a company is more efficient in selling off its inventory, while a large number indicates that a company may have invested too much in inventory, and may even have obsolete inventory on hand.

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, then 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. A company could post financial results that indicate a low DSI, 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.

The DSI measurement can also be misleading if a company changes 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.

The measurement can also be misleading if you 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.

Another cause of a misleading DSI is when a company switches 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.

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 company, since employees can access detailed reports that reveal exactly which inventory items are selling better or worse than average.

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.

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