Days Sales of Inventory (DSI), or Inventory days, is a key financial metric that measures the average number of days a company takes to sell its entire inventory during a specific period. DSI offers valuable insights that can help you make significant improvements in the following areas:
Inventory holding: The DSI can reveal whether your business carries too much or too little stock. Excess stock ties up cash. On the other hand, too little stock could lead to stockouts and lost sales. The days in inventory calculation help to balance these two extremes. Inventory holding and working capital management also reveal how well the business manages customer acquisition and marketing tactics.
Enhanced cash flow: Pursue a lower DSI to quickly convert inventory into cash. Your business can then use the funds for other business activities, like operational expenses and debt payments.
Reduced costs: Inventory holding costs include the cost of warehouse space, insurance, obsolescence, and interest on capital. These costs drop along with on-hand inventories.
Accelerated profitability: Lower inventory holding costs and higher sales boost business profits.
Let’s discover how to use the inventory turnover ratio and days sales of inventory.
What is day sales of inventory (DSI)?
Days Sales of Inventory (DSI), or inventory days, is a financial formula used to measure how long it takes a business to convert its inventory to revenue. In other words, DSI measures how fast a business cycles through its stock.
A lower DSI shows faster inventory turnover, suggesting that the business isn’t holding large stocks of excess inventories. Inversely, a higher DSI suggests slow-moving stocks.
DSI is useful for evaluating inventory management practices. It provides a measure for management to assess the business’s inventory performance against industry standards and past performance.
Why is DSI important to track?
DSI is a critical metric because it’s a window into inventory management efficiency, operational effectiveness, and working capital management. It can help businesses to find the balance between minimal inventory and enough stock to meet customer demand.
Excess inventories, as suggested by a high DSI, can lead to:
- Cash flow issues: Excess inventory ties up cash that could be used for other purposes.
- Storage costs: Storing large amounts of inventory incurs unnecessary costs.
- Obsolescence: Outdated products lead to write-downs and wasted resources.
Operational Efficiency
DSI highlights how efficient a business’s operational cycle is. A healthy DSI can indicate:
- Effective demand forecasting: The business accurately predicts customer demand and orders the right amount and mix of inventory.
- Optimized production: Production matches sales needs without overproduction or unnecessary inventory accumulation.
- Efficient order fulfillment: With the right stock levels, businesses fulfill customer orders efficiently, with fewer delays and backorders.
Working Capital Management
DSI affects a company’s working capital directly. Working capital is the difference between current assets (like inventory) and current liabilities (like short-term debts). A lower DSI indicates:
- Faster cash conversion: Inventory is quickly converted into cash, freeing up working capital for other needs.
- Improved liquidity: The business has more cash available to cover operational expenses.
- Financial flexibility: Healthier working capital enables the pursuit of growth opportunities.
What is the formula for day sales of inventory?
The days of inventory calculation is as follows:
DSI = Average Inventory/Cost of Goods Sold (COGS) x Days in a Period (usually 365 days in a year)
Where:
-
- Average inventory: The average inventory is the sum of the opening inventory and closing inventory divided by two.
- COGS: The direct costs of producing goods sold during the period. These costs include direct labor, utilities, and materials. They do not include transportation, advertising, or marketing costs. COGS can be found on the income statement.
- Number of days: This could be 365 days in the year, 90 days in a quarter, or 30 days in a month.
Here’s a simple example
Let’s assume that a company has an opening stock of $20,000 and a closing stock of $25,000. The cost of goods sold in a year is $150,000.
- Average inventory = ($20,000 + $25,000)/2 = $22,500
- DSI = ($22,500/$150,000) x 365 days = 54.75 days
It takes this company an average of 54.75 days to convert inventory to cash. The interpretation of a good DSI depends on the industry.
What’s the difference between DSI and inventory turnover?
DSI and inventory turnover ratio are both used to assess inventory management efficiency. However, they differ slightly in perspective. DSI is a measure of inventory age since it shows the number of days between receipt of inventory and the revenue earned for the sale of the inventory. A lower DSI shows faster inventory turnover.
Inventory turnover measures inventory flow. It reflects how often your inventory is sold and replaced over a period. A higher inventory turnover indicates faster inventory movement. One is the inverse of the other.
Businesses track both metrics to compare their industry performance against industry standards to find areas for improvement.
Utilizing DSI and inventory turnover together
In inventory analysis, DSI and inventory turnover are two sides of the same coin. Still, you can use them together in strategic inventory management. Here’s how:
- Benchmarking: Compare your company averages for both DSI and inventory turnover with industry benchmarks. Use it to identify improvement areas.
- Trend analysis: Track the DSI and inventory turnover over time. Look for trends indicating issues like overstocking, understocking, or demand changes.
- Combined interpretation: A high DSI and a low inventory turnover ratio suggest slow-moving inventory. Consider clearing stocks through sales promotions, discounts, or better ordering. If the DSI is low well done but make sure you have enough stock to meet customer demand.
Combined metrics can offer practical uses, including:
- Order quantity optimization: Use the metrics to calculate the ideal order quantities.
- Cash flow improvements: Keep the DSI low and inventory turnover high to ensure faster inventory conversion. You’ll reap the benefits of improved cash flow, which you can use for other investments or expenses.
- Lower storage costs: A lower DSI means less idle inventory, occupying warehouse space, and running up costs.
- Less obsolescence: Maintaining higher inventory turnover and lower DSI reduces the risk of obsolescence.
- Demand forecasting: Analyzing DSI and inventory turnover alongside historical sales will help you identify seasonal trends and changes in customer preferences, resulting in improved forecasting.
Low days sales of inventory
If you have a low DSI, your business is selling its inventory efficiently and quickly converting it into cash – generally a positive for inventory management and business performance. Situations may, however, occur where a very low DSI may need adjusting.
Definition of low DSI:
A “low” DSI value has no absolute definition. It varies based on the industry, but there are certain guidelines. A lower DSI is generally favorable. Compare your DSI to industry averages to assess your performance.
Analyze your DSI over time to identify trends.
Strategies for improving Your DSI
It may be time to develop strategies and inventory management practices to improve your inventory efficiency if your DSI is higher than the industry benchmark. Areas for improvement include:
- Demand forecasting: Improve demand forecasting to meet customer needs even when demand surges.
- Supplier relationships: Develop strong supplier relationships for reliable and timely deliveries.
- Safety stock: Maintain a safety stock of critical items. This should buffer the business against unexpected demand surges or supply chain disruptions.
- Just-in-Time (JIT) inventory management: Consider implementing JIT systems if your business model and supplier relationships allow. These systems will minimize inventory holding costs while maintaining adequate stocks to prevent business interruptions.
An ideal DSI should balance efficient inventory management with enough stock to avoid stock-outs.
How can inventory optimization improve DSI?
Stock reduction principles drive Inventory optimization techniques. Lower inventories quickly convert stock into cash, bringing down the DSI.
Optimized inventories need enhanced demand forecasting. Better forecasting enables you to order the right products at the right time, keeping stock levels down and reducing the risk of stock-outs. When the forecast aligns with actual demand your DSI will stay at ideal levels.
Inventory optimization techniques for enhanced DSI
There are several techniques you can adopt for enhanced DSI, including:
- ABC analysis: Classify your inventory items based on their value and demand (A – high value/high demand, B – moderate, C – low). Use the analysis to focus your inventory management efforts on high-impact items.
- Safety stock management: Calculate and maintain safety stocks of critical items. The idea is to buffer against unexpected demand surges or supply chain disruptions.
- Vendor-Managed inventory (VMI): Collaborate with suppliers to manage inventory levels.
- JIT inventory: Consider using a JIT system where inventory arrives just before it’s needed.
Leveraging technology and data analytics for DSI improvement
Modern technologies and data analytics can transform your stock optimization and improve your DSI. Here’s how:
Improved demand forecasting: Advanced analytics and machine learning analyze vast amounts of data, including historical sales, market trends, and even customer sentiment. This data integrates with real-time information from point-of-sales and other systems, creating a powerful data analytics tool. Modern systems make dynamic forecast changes based on actual sales, resulting in lower stocks and reduced risk of stock-outs. Use analytics to set what-if scenarios. Find out how promotions and economic changes affect your inventories and demand forecast. Use the information to assist with decision-making.
Right-sizing inventory levels: Invest in robust inventory management software. Use it to automate your order placement and provide real-time inventory tracking across all relevant locations. Eliminate manual tracking and human error. Use data-driven inventory to place inventory in the best location for forecast demand fulfillment. Ensure that high-demand items are in the right warehouses when needed.
Streamlined supply chain processes: Use Electronic Data Interchange (EDI) for streamlined supply chain processes. Exchange inventory levels, purchase orders, and invoices in real-time, database to database. EDI ensures that both parties work off the same information.
Just-in-time inventory management: Receive products and raw materials when you need them to support production. The system aims to streamline the supply chain and reduce associated waste. JIT relies on small, frequent deliveries, ensuring a steady flow of materials and reducing needed storage space. Good communication and collaboration with suppliers are prerequisites for JIT systems to work. Accurate demand forecasting ensures that the right components arrive, avoiding production delays.
SKU rationalization: SKU rationalization involves evaluating each Stock Keeping Unit (SKU) in your inventory and deciding whether to drop, keep, or change it.
The underlying objective is to lower the DSI by:
- Improving inventory efficiency: By eliminating slow-moving or unprofitable products.
- Boosting profitability: You can more effectively allocate resources to increase your profit margins when you focus on high-demand, profitable products.
- Simplifying operations: A streamlined product line simplifies purchasing, warehousing, and product management processes, resulting in improved operational efficiency.
- Enhancing customer fulfillment: Improve customer satisfaction and brand perception by offering them a more thoughtful product mix.
Utilization of technology can help you select the ideal product mix by analyzing historical sales, stock turnover, and profit margins. Use technology to create a more efficient and focused product portfolio.
Use the DSI to find improvement opportunities
Efficient inventory management is often the difference between highly successful businesses and those that just don’t make it. Optimized inventories keep your costs down, ensure happy customers, and enable better use of working capital. The days of inventory calculation can help you to track your performance against industry benchmarks.
