How many days will it take for your company to sell its entire inventory? Well, if you have no idea, then you can calculate the Days Sales in Inventory, also known as Days Inventory Outstanding or just Days in Inventory.
This financial ratio is used to determine how long a company’s stock of items will last. When it comes to investors and creditors, there are three main reasons for which they think this is an important factor to look into in a company.
The Basics of Days Sales in Inventory
The three reasons are cash flows, liquidity, and value. The Days Sales in Inventory is used to see how important your company’s inventory is – basically if it is actually capable of being sold or not.
This is due to the fact that older items signal an obsolete inventory, which is worth a lot less than a fresh inventory. You could say that this ratio measures the freshness of your inventory – how fast your company can sell its current batch of products so that it can be restocked with fresh, non-obsolete items.
Liquidity is also an important factor for investors and creditors and it is tightly connected to the company’s cash flow. When your company has shorter Days Sales in Inventory, it means that your business is able to convert its products/ inventory into cash at a faster rate – very short days of inventory outstanding mean that the inventory of products is extremely liquid.
The Formula of Days Sales in Inventory
In order to find out the ratio of the inventory outstanding of your company, you have to divide the ending inventory by the cost of goods sold for a certain period and then multiply the result by 365.
The cost of goods sold can be found listed on the income statement of your company and the ending inventory on its balance sheet. Moreover, you can calculate the Days Sales in Inventory for any time period – you just have to modify the multiplier accordingly.
However, if you want to find out the average inventory outstanding, you can use the inventory turnover ratio in the equation – meaning that you have to divide 365 by the ratio of the inventory turnover.
Days Sales in Inventory is extremely important to a company as it is a part of the inventory management and of how the company handles this aspect. You already know this, but inventory is a hassle – of course, it eventually gets converted into cash, but until that happens, you have to store, keep, and maintain it.
Moreover, the inventory must always be under protection, and not only protection from theft – the company’s management has to prevent it from becoming obsolete.
The management team has to find ways to move the company’s inventory as fast as possible in order to minimize the costs we have mentioned earlier – those of storing, keeping, and maintaining – and, therefore, to increase its cash flows.
Inventory is basically the money of the company. However, it is locked on the shelf, meaning that the said company can’t use its money for other investments or for the purchase of fresh inventory.