Knowledge of days in inventory is key within inventory management as a function to ensure profitability. Unsold or obsolete inventory means your business will be in trouble sooner or later.
Calculating days in inventory (DSI) helps you to know how effective your business is when it comes to managing inventory and its valuation. In this article, we have explained what is days in inventory, its importance, how to calculate DSI, its advantages, indicators, and more.
What Is Days in Inventory (Days Sales Inventory)?
Days in inventory or Days Sales Inventory is a financial ratio that helps us to find out the average time a business takes to convert inventory into sales. The work-in-progress goods in the inventory are also taken into consideration for the purpose of calculation.
For finding the value of DSI, divide the inventory balance by the total sum of the cost of items sold. Following this, we multiply this number by the total number of days in a month or year.
DSI figure is also used to calculate the cash conversion cycle. It is the average number of days required by the company for converting resources into cash. The DSI number also indicates the number of days on average in which the inventory assets of a company are converted into sales during the year.
Using the following formula DSI can be calculated as:
DSI = (Inventory / Cost of Goods Sold) x (No. of Days in the Period) In general, it can be said that a company is inefficient in making enough sales to clear inventory if the DSI value is high and vice-versa.
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Why Are Days in Inventory Important?
Let us look at some reasons why it is essential to know how soon you can convert inventory into sales.
1. Effect on cashflow and profitability
It is essential to maintain a low DSI for improved cash in hand. With enough cashflow, you can spend the freed-up money in other departments wherever needed instead of spending a lot of money on warehousing.
It is possible for your resources to get drained out by purchasing an excessive amount of inventory. In case there is no more demand for the product it can affect your company financially. The Days on Hand formula will be useful in such cases.
2. Impact on inventory management
If DSI is high, the company needs to seriously work on its inventory management department or inventory itself. Either it is unable to manage its inventory or the product is not good enough or seasonal and has low demand. For inventory management, it needs to avoid surplus and avoid shortage by tracking and forecasting inventory.
3. Relationship between days in inventory and customer demand
With the DSI metric, you can know the customer demand and do demand forecasts. E-commerce merchants and businesses need to make smart decisions regarding inventory purchases. One can do this by figuring out your day sales in inventory.
Suppose a business has a DSI of 50, it means it has 50 days to restock its inventory or produce goods. It also tells you how much demand is there for your product. Accordingly, you can adjust your product marketing, product improvement, production enhancement, and other aspects.
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How to Calculate Days in Inventory?
You can calculate DSI using the formula mentioned below: Days in Inventory = (Average Inventory / Cost of Goods Sold) x Period Length (i.e. 365 for year and 90 for quarter) Here
- Length of the period can be 365 for a year and 90 for a quarter
- Average Inventory = (Beginning Inventory + Ending Inventory) divided by 2
- Cost of Goods Sold covers the entire direct cost of manufacturing a product
Steps to Calculate DSI
Days in Inventory (DSI) helps businesses understand the average time taken to convert their entire inventory into sales. The formula to calculate DSI is as follows: Days in Inventory=(Average Inventory/Cost of Goods Sold)×Period Length
Where:
- Period Length could be 365 for a year or 90 for a quarter.
- Average Inventory is calculated as ( Beginning Inventory+Ending Inventory ) / 2
- Cost of Goods Sold includes all direct costs of manufacturing a product.
Steps to Calculate DSI:
1. Calculate Average Inventory:
- Add the total value of inventory at the beginning of the period to the total value at the end of the period.
- Divide the sum by 2 to find the average inventory.
- Example: If the beginning inventory is Rs. 3,000 and the ending inventory is Rs. 7,000, the average inventory is (3,000+7,000) / 2 = Rs.5,000.
2. Compute Cost of Goods Sold (COGS):
- Add the value of the inventory at the beginning of the period to the cost of additional inventory purchased or produced during the period.
- Subtract the value of the inventory at the end of the period.
- Include all direct costs such as labor and materials.
- Example: If the beginning inventory is Rs. 3,000, the additional inventory cost is Rs. 50,000, and the ending inventory is Rs. 7,000, the COGS is (3,000 + 50,000) − 7,000 = Rs.46,000.
3. Determine the Length of the Period:
- Decide the time for which you are calculating DSI.
- Convert the length of the period into days.
- Example: For a yearly calculation, use 365 days.
4. Divide Average Inventory by COGS:
- Use the values from steps 1 and 2 to perform this division.
- Example: With an average inventory of Rs. 5,000 and COGS of Rs. 46,000, the result is
- (5,000 / 46,000) ≈0.1087
5. Multiply the Result by the Number of Days in the Period:
- Multiply the result from Step 4 by the number of days determined in Step 3.
- Example: 0.1087 × 365 ≈ 39.7 days.
- This is your Days in Inventory.
Example Calculation:
Consider a company that sells spare components and provides repair services. The average inventory is Rs. 5,000, and the cost of goods sold is Rs. 46,000 for the year. To find the DSI for one year:
DSI = (5,000 / 46,000) × 365 ≈ 39.7 days
This result indicates that, on average, it takes the company around 39.7 days to sell its entire inventory. A lower DSI would imply faster inventory turnover, suggesting efficient inventory management and financial operations.
Why Businesses Should Care About Days in Inventory?
Manage the flow of cash
Low average days inventory is crucial for managing your cash flow. For instance, suppose you are aware of the fact that reordering inventory will be required by you in one month. In such cases, this can be factored into your flow of cash projections so that there is adequate cash available for covering the expenses related to ordering as well as stocking fresh inventory.
Plan and control the levels of stock
You will be able to plan your levels of stock more efficiently by figuring out your average days in inventory and inventory turnover. DSI will tell you how soon the stock will finish and in how many days stock will be required to satisfy the customers’ demand. Consequently, it will assist you in avoiding overstocking the inventory as well as running out of stock.
Make better business decisions
It is important to have precise information on DSI for making better business decisions. The average days in the inventory will inform you about the performance of the company from the perspective of clearing stock. For instance, in case the average day's inventory number is high, it will signify that your business must manage its stock levels in a better way and vice versa.
Assess product demand
You can easily comprehend product demand for a specific product by knowing the average days in inventory. For instance, low days in inventory might imply that the demand for that product is high as sales are high.
Days in Inventory vs Inventory Turnover
Days in inventory (DII) and inventory turnover are different but important financial ratios that tell how good the inventory management of a business is.
As discussed above, it measures the number of days for a company to sell its complete inventory on average. It can be calculated using the DII or DSI formula.
Inventory turnover is yet another business metric that tells you how many times the inventory has been sold and new inventory has been bought in a certain period. On the other hand, measures how many times a company sells and replaces its inventory in a given period. You can easily calculate it using the Inventory Turnover formula.
DSI is calculated in days, while inventory turnover is calculated in units of inventory sold. Both these metrics are very significant for evaluating inventory efficiency.
High DSI means more time to make sales which is a negative indicator while high inventory turnover means speedier inventory selling. Quick turnover depicts a strong customer demand for the product of a company.
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Benefits of Calculating Days in Inventory
By calculating inventory days of supply, you can focus on inventory management and know the areas for improvement in operations by using the days in the inventory formula.
You can fix inefficiencies in inventory management practices that will lead to less inventory storage costs, minimize waste, and improve ROI. If DSI is high, you can determine optimal pricing for your product after analyzing product demand and competition.
DSI also tells you about your product demand, so you can forecast future sales. Businesses can optimize their cash flow when the inventory level is maintained as per demand. This ensures there is no surplus inventory. Also, the cost of storage will be less in case each product spends less time in inventory. Another important metric is Days in Inventory Outstanding (DIO), which is the average number of days a company needs to hold its inventory before it is sold. By managing your inventory well, you gain a significant competitive edge.
Read Also: Accurate inventory management
Days in Inventory Example
Here, we have cited 2 examples of inventory days calculation.
The average inventory of a dental goods supplier is worth Rs. 10,000 and the cost of items marketed is Rs. 40,000 for one year. Let’s calculate the DSI for one year. Using the formula DSI = (Average Inventory / Cost of Goods Sold) x 365 We need to calculate (Rs. 10,000 / Rs. 40,000) x 365 to find the DSI.
So, the DSI happens to be approximately 91 days. This result is quite high indicating that the company needs to look into its inventory management and identify the loopholes. A DSI between 30 and 60 days is considered good by experts.
Let’s take another example where the average inventory cost of a grocery outlet is Rs. 500 for a year, and the cost of items sold is Rs. 15,000. To calculate its DSI using the formula, let’s see what we get. DSI = (Average Inventory / Cost of Goods Sold) x 365 DSI= (Rs. 500 / Rs. 15,000) x 365 As indicated by the results, the DSI for the company will be 12 days. The result seems quite good for a grocery outlet.
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Low and High DII/DSI
A low DII/ DSI will indicate that a company can transform its inventories into sales efficiently. One can consider this to be beneficial for the margins of the company as well as its bottom line. So, the objective is to have a lower DSI compared to a higher DSI.
On the other hand, an extremely low DSI might indicate that there is not adequate inventory with the company to satisfy demand. This can be regarded as suboptimal in such cases.
A low DSI indicates less time is taken for inventory stock sales which helps to increase the flow of cash and reduces the costs of handling. On the contrary, a high DSI value signifies a slow sales performance and an excessive amount of purchase inventory.
Some signs that your company has a high DSI: a. Surplus inventory that is not moving quickly. b. Inventory that is difficult to sell. c. Cash flow issues due to inventory holding costs. d. High risk of inventory becoming obsolete. e. Low profits due to the high cost of keeping inventory.
Some signs that your company has a low DSI value: a. Enhanced revenues with quick sales of inventory. b. Steady sales results in revenue growth. c. Minimal risk of inventory getting obsolete. d. Improved cash flow due to lower inventory holding costs.
Focus on Reducing Inventory Days Ratio for Business Success!
DSI is a financial ratio or a business metric, you ideally must not ignore. Your objective must always be to achieve a low number of days in inventory. You can do so by managing your inventory well so that there is no waste or obsolete inventory. TranZact’s Cloud-ERP solutions can help you in inventory management and many other core business functions like production management, sales management, finance management, and more.
FAQs on Days in Inventory
Q1. Are high days sales in inventory good?
No, high days sales in inventory (DSI) is not good. This is because a high DSI signifies that it is not possible for the company to manage and sell its inventory quickly. When selling inventory becomes difficult or too slow, it hampers business growth.
Q2. What causes days sales in inventory to increase?
Some causes of high-day sales in inventory are sales moving slowly, bulk inventory, issues in the supply chain, quality problems, seasonal products, high pricing, high competition, and poor inventory management.
Q3. What is the best inventory-to-sales ratio?
A decent inventory-to-sales ratio will be below 'one' and businesses try to go for something ranging from 0.17 to 0.25. However, it varies depending on the type of business and industry.
Q4. What is the difference between days in inventory and inventory turnover?
Both are financial ratios or business metrics that help to evaluate the efficiency of a company's inventory management. Days in inventory (DII) indicates the average number of days taken for selling the entire inventory, whereas inventory turnover indicates the frequency of selling and replacing inventory in a given period.
Q5. How to improve days in inventory?
It is possible to improve the days in inventory by enhancing demand forecasting precision. Moreover, you should also focus on handling competition, improving product quality, and pricing the product suitably.
Q6. What is a good DSI ratio?
A good Days in Inventory (DSI) ratio typically ranges between 20 to 30 days, though this can vary depending on the industry and the nature of the products. A lower DSI indicates faster inventory turnover, suggesting efficient inventory management.
Q7. How can high DSI be reduced?
Reducing high DSI can be achieved by improving inventory management practices, such as optimizing stock levels, enhancing demand forecasting, speeding up the sales process, and discontinuing slow-moving products.
Q8. Why is DSI important for my business?
DSI is crucial as it helps businesses understand how efficiently they are managing their inventory, directly impacting cash flow and profitability. A lower DSI ensures that capital is not tied up in inventory for long periods, freeing up resources for other operational needs.
