The days sales in inventory is a measure that tracks how many days of sales the current inventory level can sustain. This metric provides a valuable insight for the management team to forecast many different variables related to the supply chain of the company including how much raw materials need to be purchased, how many workers have to be active, along with many other key decisions associated with reducing or increasing the inventory levels depending on the result of the day sales in inventory metric.
What is the Days Sales in Inventory Ratio?
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Sales budgets include estimations on how much money can be sold during a certain period and how much inventory is needed to achieve such results. A sales team can only sell available inventory, therefore, tracking the day of sales in inventory can help the company anticipate potential issues in its sales.
On the other hand, seasonal businesses also have to keep track of this metric to make sure they are stocked up to cover the season’s high demand, which involves a significant increase in the day sales in inventory, to compensate for the peak.
The main purpose of this measure is to track how adequate are the current inventory levels based on the level of revenues that are coming in per day.
Days Sales in Inventory Formula
The days of sales in inventory formula is calculated below:
Day of Sales in Inventory = Avg. Inventory / (COGS or Net Sales / Number of Days)
Days Sales in Inventory Equation Components
Average Inventory: It can be interpreted as the beginning and ending inventory divided by 2 for a particular time period, or, it could also be defined as the ending inventory. Commonly, inventory values are expressed on a cost basis.
Cost of Goods Sold (COGS) or Net Sales: Depending on the accounting practices, the value of inventory can either be express on a cost or price basis. If they are expressed in a cost basis then the COGS should be employed, if they are expressed in a price basis, then Net Sales should be employed for the formula.
Number of Days: It refers to the number of days of the time period being analyzed. If its an analysis of a company’s annual results then the number of days should be 365.
Another way to express the formula would be the following:
Day of Sales in Inventory = Number of Days / (COGS or Net Sales / Avg. Inventory)
In any case, the result of the formula would be the number of days it has taken the company to sell its entire inventory, on average, or it could also be determined as the current number of days of inventory available for sales.
Days Sales in Inventory Example
Sauce Kings is a company that manufactures different types of sauces such as ketchup, mustard and mayonnaise. They currently measure their inventory in metric tons and they have right now 120,500 metric tons of sauce ready to be sold, valued at $12 each, which means the current inventory is $1,446,000. Also, 183 days have passed since the calendar year started and they have sold $3,760,000 with a 50% markup, which means the COGS of these sales is $2,506,666.
The sales pattern has been very consistent and the management don’t really expect a big increase in the sales volume. Yet, they wanted to estimate how suitable are the current inventory levels to meet the current demand. In order to do so, the days sales in inventory metric was calculated by using the information given above:
Days of Sales in Inventory = $1,446,000 / ($2,506,666 / 183) = 105 days.
By employing the alternative formula we can confirm that the result of this calculation is correct:
Day of Sales in Inventory = 183 / ($2,506,666 / $1,446,000) = 105 days.
According to this formula, the company has more than 3 months of inventory, which is actually much higher than their target, which was 2 months. For this reason, they decided to issue a fire sale on the inventory with the lowest turnover rate, to reduce inventory levels to optimal volumes.
Days Sales in Inventory Ratio Analysis
By analyzing the Days of Sales in Inventory, the management team of a business can make decisions regarding pricing and raw material purchases, along with many other modifications to the current sales strategies, in order to achieve the sales goals.
This metric should always be compared to the company’s capacity to stock-up. For example, a retail business with suppliers that take more than 15 days to deliver an order, must always have at least 30 days of days of sales in inventory to make sure there are enough products to be sold.
Also, if a company is currently aiming to increase its sales it should maintain a level of inventory that is worth substantially more than the average monthly sales in order to have enough products to achieve the sales increase it is aiming for.
Finally, a substantially high days of sales in inventory metric may indicate that the company is struggling to move its inventory, possibly because of a loss in its competitiveness or a market downturn. Frozen inventory can drive a business to face severe cash flow issues if it can’t quickly turn the situation around.
Days Sales in Inventory Uses, Cautions, Pitfalls
One of the most important things to watch for when estimating the days of sales in inventory measure is the way the inventories are valued. If inventories are valued by price, net sales have to be employed rather than COGS to calculate the metric.
On the other hand, obsolete or damaged inventory have to be taken out of the formula to make sure only available inventory is included. If unavailable inventory represents a substantial portion of the calculation, it can distort its end result.
In some cases, the most accurate way to estimate the actual number of days of sales in inventory is to only include finished goods, as those are the ones actually available for sale. Including inventory in early stages of the production process may also distort the calculation as that inventory will not be immediately available to be sold.