Days sales in inventory, sometimes known as inventory days or days in inventory, is a measurement of the average number of days or time required for a business to convert its inventory into sales. The days sales in inventory value is calculated by dividing the inventory balance (including work-in progress) by the amount of cost of sales or goods sold. This number is then multiplied by the number of days in a year, quarter, or month. The result represents the average number of days that a company’s inventory assets are realized into sales within the year. Days sales in inventory is also one of the measures used to determine the cash conversion cycle, which is the company’s average days to convert resources into cash flows.
To determine how many days it would take to turn company’s inventory into sales, the following formula is used:
For the year-end 2015 financial statements, Target Corp reported an ending inventory of $1M and a cost of sales of $100M. Given the figures, the days sales inventory for the year is 3.65 days, meaning it takes approximately 4 days for the company to sell their stocks.
Generally, a small average of days sales, or low days sales in inventory, indicates that a business is efficient, both in terms of sales performance and inventory management, hence it is more favorable than having a high days sales in inventory. Low days sales in inventory reflects fast sales of inventory stocks and therefore would minimize handling costs as well as increase in cash flow. On the other hand, a high days sales in inventory value generally indicates either a slow sales performance or an excess of purchased inventory (the company is buying too much inventory), which may eventually become obsolete. However, it may also mean that a company with a high days sales in inventory has been maintaining high inventory levels to meet high customer demands.
It is also important to note that the average days sales in inventory differs from one industry to another. To obtain an accurate days sales in inventory value comparison between companies, it must be done between two companies within same industry or that conduct the same type of business. For instance, a retail store like Wal-mart can be compared to Costco in terms of inventory and sales performance.
For a company that sells more goods than services, days sales in inventory is an important indicator for creditors and investors, because it shows the liquidity of a business. These interested parties would want to know if a business’s sales performance is outstanding; therefore, through this measurement, they can easily identify such. The more liquid the business is, the higher the cash flows and returns will be. Management is also interested in the company’s days sales in inventory to determine how fast inventory moves which is important when taking storage and maintenance expenses of holding inventory into account. The carrying cost of inventory, which includes, rent, insurance, storage costs, and other expenses related to holding inventory, may directly impact profit margin if not managed properly. In addition, the longer the inventory is kept, the longer its cash equivalent isn’t able to be used for other operations, and thus opportunity cost is lost.