What is Days Sales of Inventory (DSI)?
– Days Sales of Inventory (DSI) measures how many days, on average, a company holds inventory before it is sold. It is an indicator of inventory liquidity — how long cash is tied up in unsold stock.
Key definitions (first use)
– Cost of Goods Sold (COGS): the direct costs of producing or acquiring the products that a company sells during a reporting period (materials, direct labor, manufacturing overhead).
– Inventory turnover: the number of times inventory is sold and replaced during a period; mathematically, COGS divided by average inventory.
– Obsolescence: inventory that loses value because it becomes outdated or unsellable.
– Liquidity (of inventory): how quickly inventory can be converted into sales (and eventually cash).
Core formula and variants
– Standard annual DSI:
DSI = (Average Inventory / COGS) × 365 days
where Average Inventory can be:
– Ending Inventory (if you want a point-in-time measure), or
– (Beginning Inventory + Ending Inventory) / 2 (to approximate the period average).
– Alternative expression using inventory turnover:
Inventory turnover = COGS / Average Inventory
Therefore DSI = 365 / Inventory turnover
– Notes on days: use 365 for a year or 90 for a quarter; some analysts use 360 for convenience.
How to calculate (step-by-step checklist)
1. Select the period (annual or quarterly).
2. Get COGS for the period from the income statement.
3. Determine Average Inventory:
– For period analysis: (Beginning Inventory + Ending Inventory) / 2.
– For point-in-time: use Ending Inventory only.
4. Plug values into DSI = (Average Inventory / COGS) × days-in-period.
5. Compare the result to:
– The company’s historical DSI (trend),
– Peers in the same industry (sector norms vary widely),
– Related ratios such as inventory turnover and current ratio.
6. Investigate large or changing DSI values for seasonality, changes in accounting policy (FIFO/LIFO), promotions, or obsolescence.
Worked numeric example
– Company A annual data:
– Beginning Inventory = $40,000
– Ending Inventory = $60,000
– COGS for the year = $300,000
– Step 1: Average Inventory = (40,000 + 60,000) / 2 = $50,000
– Step 2: DSI = (50,000 / 300,000) × 365 = 0.1667 × 365 ≈ 60.8 days
– Interpretation: On average, Company A holds inventory about 61 days before it becomes sales.
What DSI tells you (interpretation)
– Lower DSI: inventory moves faster; cash is freed sooner. Often indicates efficient operations and strong demand, but very low DSI can signal stockouts (lost sales).
– Higher DSI: inventory sits longer; cash tied up and risk of markdowns or obsolescence increases. But a high DSI may be intentional (building seasonal stock, hedging expected shortages, or holding expensive slow-turning items like heavy equipment).
– Industry context matters: perishable goods and fast-moving consumer goods (FMCG) typically show low DSI; capital goods, autos, and some tech/manufacturing firms often have higher DSI.
Important relationship with inventory turnover
– DSI and inventory turnover are inversely related:
DSI = 365 / Inventory turnover
– Use both measures together: turnover tells how many times inventory cycles; DSI converts that into days.
Limitations and cautions
– Cross-industry comparisons are misleading; always compare within the same sector.
– Season
ality and timing — raw DSI comparisons can be distorted by seasonal stocking patterns. Compare the same fiscal periods (e.g., Q4 vs Q4) or use trailing twelve months (TTM) averages to reduce seasonality noise.
Inventory accounting and valuation — cost-flow methods (FIFO = first-in, first-out; LIFO = last-in, first-out) and cost basis (cost vs. lower of cost or net realizable value) change reported inventory and cost of goods sold (COGS). For example, in rising-cost environments, FIFO reports higher inventory and lower COGS than LIFO, which pushes DSI higher under FIFO. Always read the footnotes for the company’s inventory policy.
One-off events and write-downs — inventory write-offs, impairments, or major product discontinuations can spike DSI or suddenly reduce it; check footnotes and MD&A (management discussion & analysis).
Product mix — a move toward slower-turning SKUs (stock keeping units) or more capital-intensive products will increase DSI even while sales grow. Break down inventory by category when possible.
How to calculate DSI — step-by-step
1) Choose the DSI formula you’ll use. Two common variants:
– COGS-based (preferred for matching principle): DSI = (Average Inventory / COGS) × Days
– Turnover-based: Inventory Turnover = COGS / Average Inventory; DSI = Days / Inventory Turnover
Note: Days is usually 365 (or 360 for some banking/industry conventions). Use TTM (last twelve months) COGS to smooth seasonality.
2) Get inputs from financial statements:
– Average Inventory = (Beginning Inventory + Ending Inventory) / 2 for annual analysis; for better accuracy use quarterly or monthly averages if available.
– COGS = found on the income statement; use TTM if comparing across seasons.
3) Compute inventory turnover and/or DSI.
Worked numeric example (annual, preferred COGS-based method)
– Company A: TTM COGS = $2,500,000; Beginning Inventory = $450,000; Ending Inventory = $550,000.
Step 1: Average Inventory = (450,000 + 550,000) / 2 = $500,000.
Step 2: Inventory Turnover = COGS / Average Inventory = 2,500,000 / 500,000 = 5.0 turns.
Step 3: DSI = 365 / Inventory Turnover = 365 / 5.0 = 73.0 days.
Alternate direct formula: DSI = (Average Inventory / COGS) × 365 = (500,000 / 2,500,000) × 365 = 73 days.
If you use revenue (sales) instead of COGS: DSI_sales = (Average Inventory / Revenue) × 365. This is less preferred because it mixes balance-sheet inventory with top-line sales; matching is weaker.
Example: CCC (Cash Conversion Cycle) — combines working capital timing metrics
– Definitions:
– DSO (Days Sales Outstanding) = (Average Accounts Receivable / Revenue) × 365 — measures days to collect sales.
– DPO (Days Payable Outstanding) = (Average Accounts Payable / COGS) × 365 — measures days to pay suppliers.
– CCC = DSO + DSI − DPO.
– Numeric example:
– DSO = 40 days; DSI = 73 days (from above); DPO = 50 days.
– CCC = 40 + 73 − 50 = 63 days. This means the company needs 63 days of operating capital between paying suppliers and collecting cash from customers.
Checklist for practical analysis (step-by-step)
1) Choose consistent period and formulas (use TTM COGS and 365 days unless industry convention differs).
2) Compute average inventory using the number of periods that fits seasonality (monthly/quarterly averages preferred for seasonal firms).
3) Compare DSI to:
– Company’s own trend (YoY, QoQ).
–
– Peers / industry median (same product mix and channel).
– Business model (make-to-stock retailers tend to show higher DSI than make-to-order manufacturers).
– Seasonality (adjust comparisons to the same quarter or use rolling 12-month averages).
– Inventory composition (raw materials, work‑in‑process, finished goods — long WIP pushes DSI up).
– Channel and distribution (consignment, third‑party logistics, drop‑ship arrangements can distort on‑balance inventory).
– Accounting and valuation method (FIFO/LIFO, lower‑of‑cost‑or‑net‑realizable‑value write‑downs).
– Management policy (target safety stock levels, vendor-managed inventory, JIT programs).
4) Adjust for seasonality and one‑offs
– Use monthly or quarterly average inventory when sales/production are seasonal.
– Remove one‑time events (large inventory build for an acquisition, pandemic stockpiling) or annotate their impact.
5) Decompose inventory where possible
– Separate raw materials, WIP, finished goods. Compute DSI for finished goods if sales are the focus.
– Review aged inventory disclosures and inventory obsolescence/write‑downs in footnotes.
6) Use complementary ratios and checks
– Inventory Turnover = COGS / Average Inventory (times per year).
– DSI = (Average Inventory / COGS) × 365 = 365 / Inventory Turnover.
– Cross‑check with gross margin trends, days sales outstanding (DSO), days payable outstanding (DPO), and cash conversion cycle (CCC).
7) Red flags to watch for
– Rising DSI while sales decline — possible bloated or obsolete inventory.
– Rising DSI with falling or stable gross margin — could indicate discounts or markdowns to clear stock.
– Very low DSI with missed deliveries or stockouts — potential lost revenue or under‑stocking risk.
– Frequent inventory write‑downs — signal valuation problems or quality/obsolescence issues.
8) Practical data‑audit checklist (quick)
– Source COGS from the income statement (use TTM unless analyzing a specific seasonal quarter).
– Compute average inventory using the number of period observations that match seasonality (monthly preferred; at minimum opening and closing balances for the period).
– Confirm consistent units/currency and adjust for acquisitions, divestitures, or major FX effects.
– Read MD&A and footnotes for policy changes, one‑offs, and inventory valuation methods.
9) Simple worked numeric example — cash tied to inventory and interest impact
Assumptions: TTM COGS = $500
million; average inventory = $45 million; annual short‑term cost of capital = 4%.
Step 1 — compute basic ratios and DSI
– Inventory turnover = COGS / Average inventory = 500 / 45 = 11.111 turns per year.
– Days Sales of Inventory (DSI)
– Days Sales of Inventory (DSI) = 365 / Inventory turnover
– DSI = 365 / 11.111 = 32.85 days (rounded to two decimals).
Step 2 — cash tied up in inventory
– Average inventory = $45,000,000 (given). This is the cash/value tied up, on average, while goods are in stock.
Step 3 — annual interest (opportunity) cost of that cash
– Annual cost of capital = 4% (given).
– Annual interest cost = Average inventory × Cost of capital
– = $45,000,000 × 0.04 = $1,800,000 per year.
Step 4 — per‑day cost and impact of reducing DSI
– COGS per day = TTM COGS / 365 = $500,000,000 / 365 ≈ $1,369,863/day.
(Check: COGS per day equals average inventory / DSI ≈ $45,000,000 / 32.85 ≈ $1,369,863, consistent.)
– Interest cost per day = Annual interest / 365 = $1,800,000 / 365 ≈ $4,931/day.
Worked sensitivity: free cash from reducing DSI by 5 days
– Inventory freed = COGS per day × Days reduced = $1,369,863 × 5 ≈ $6,849,315.
– Annual interest saved = Inventory freed × Cost of capital = $6,849,315 × 0.04 ≈ $273,973/year.
Summary (numeric)
– Inventory turnover = 11.11 turns/year.
– DSI = 32.85 days.
– Cash tied = $45.0 million.
– Annual interest cost at 4% = $1.8 million.
– Reducing DSI by 5 days frees ≈ $6.85 million and saves ≈ $274k/year in financing cost.
Practical notes and caveats
– These calculations assume steady sales (use TTM) and that average inventory equals the working capital value freed by reductions. Seasonal or lumpy sales require matching the period frequency (monthly preferred).
– Interest savings are an economic/analysis metric, not guaranteed cash inflows. Actual cash freed depends on how the company acts (e.g., pays down debt, funds growth, or holds more cash).
– Inventory valuation method (FIFO/LIFO/weighted average) and one‑time items can distort comparability—check notes and MD&A.
– If borrowing rates differ from the firm’s weighted average cost of capital (WACC), use the appropriate marginal cost of short‑term funding for more realistic opportunity costs.
Checklist for an analyst or trader
– Verify TTM COGS and average inventory use the same currency and scope.
– Compute inventory turnover and DSI as shown.
– Convert DSI to inventory days or dollars via COGS/day.
– Apply appropriate cost of capital (short‑term marginal rate if analyzing working capital).
– Read MD&A and footnotes for inventory policies, write‑downs, acquisitions, or seasonal effects.
– Run sensitivity scenarios (± days, ± financing rate).
Educational disclaimer
This is educational material, not individualized investment advice. Use your own judgment and consult a licensed advisor before making trading or investment decisions.
Sources
– Investopedia — Days’ Sales of Inventory (DSI): https://www.investopedia.com/terms/d/days-sales-inventory-dsi.asp
– U.S. Securities and Exchange Commission — Beginners’ Guide to Financial Statements: https://www.sec.gov/education/investor-resources-and-tools/beginners-guide-to-financial-statements
– Khan Academy — Inventory and Cost of Goods Sold (FIFO/LIFO/Weighted Average): https://www.khanacademy.org/economics-finance-domain/core-finance/accounting-and-financial-statements/inventory-lifo-and-fifo/a/fifo-lifo
– Deloitte — Working capital management overview: https://www2.deloitte.com/global/en/pages/finance/articles/working-capital.html