This is an important ratio for businesses that carry a lot of inventory. The fewer the number of days of inventory outstanding means the company is more efficient in converting its inventory into cash much sooner.
The longer inventory sits on the shelves, the longer the company’s cash can’t be used for other operations. There is a point in time when it’s time to unload nonsalable inventory, particularly when your cash management results show your cash inflows are slowing.
Overview
Management needs inventory to move as fast as possible, to minimize inventory carrying costs, and to increase cash flows.
Day’s Sales in Inventory is an Efficiency Ratio that measures the number of days it takes to sell all inventory by measuring the inventory value, company liquidity, and cash flows. Day’s Sales in Inventory are also called “days inventory outstanding” or “days in inventory.”
It’s expensive for a company to keep, maintain, and store inventory—and, older, more obsolete inventory is always worth less than current, fresh inventory. Days in Inventory shows how fast the company moves its inventory and how fresh the inventory is by indicating the average number of days merchandise remains in inventory.
The formula for calculating the Day’s Sales in Inventory is the following:
(Ending Inventory / COGS) X 365
A Day’s Sales in Inventory of 10 tells you that a business has enough inventory to last the next 10 days or that you can turn your inventory into cash in the next 40 days if your average A/R Days are 30.
Shorter is Better: shorter days of inventory outstanding means the company can convert its inventory into cash much sooner.
Longer is Worse: the longer the inventory sits on the shelves, the longer the company’s cash can’t be used for other operations.
Remember, the longer inventory sits on the shelves, the longer the company’s cash can’t be used for other operations. There is a point in time when it’s time to unload nonsalable inventory, particularly when your cash management results show your cash inflows are slowing.