May 14, 2021

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Days Sales in Inventory

Days Sales in Inventory

The concept of product turnover determines how quickly the funds invested in goods will return to you, and bring a profit. This is one of the main concepts for the company’s success. In this article, we will explain what it means and how it can help your business succeed.

Definition

Days Sales in Inventory is an accounting value that demonstrates the performance of inventory management. It shows the number of days that inventory is kept in stock until it is sold. Basically, it tells you how long it takes the business to sell inventory it purchased or made. A decrease of the indicator is usually a positive sign. This indicates the fact that less and less financial resources are being diverted to create stocks.

Importance

The company needs to track inventory to make sure it has the right amount. Why is that even important? If your customers come into your store and you regularly do not have the items they are looking for in stock, they will go someplace else. They will create better profits for your competitors who will use that money to grow their business, making it harder for you to compete with them in the future.

Days Sales in Inventory

Having enough inventory is critical for business success. It might seem that the solution for this is to have a whole bunch of inventory to make sure you never run out of it. This can be a problem, especially if you are in a business where your inventory can quickly spoil. In addition, you will have a lot of working capital tied up in your inventory.

Thus, it is very important that you manage your inventory well and have just the right amount to meet the needs of your customers. There are a lot of factors that come in and can cause a shortage or lack of sales. Nonetheless, calculation of days sales in inventory helps to have a better idea of your inventory movement and the need to take action to adjust it as necessary.

Formula and Interpretation

The calculation formula for the number of days sales in inventory:

(Average annual inventory/ Cost of goods) * 365 days

As you might know, to find the average inventory for the period, you will sum up the beginning and ending balances, which can be located in the Balance sheet, and divide the amount by two. The cost of goods sold can be found on your company’s Income statement.

To evaluate the company more effectively, you will need to compare the indicator with competitors. Depending on the industry, the number of days will be different. For instance, for agriculture, it might be around 60-120 days, for the food and processing industry – 45-80, retail outlets and intermediaries – 20-45. In addition, you should evaluate the changes in this indicator for your own company over the years and how it lined up with your profits.

Days Sales in Inventory

The lower the indicator, the more efficiently the formation and the use of stocks functions. At the same time, if the ratio is too low, it can paralyze production or sales. Therefore, when forming stocks, it is worth considering the seasonal factor, changes in consumer preferences, production specifics, and force majeure.

If the indicator is outside the norm, the business management team should optimize the stock using ABC analysis as well as XYZ analysis. Reducing the amount of inventory will save finances, that is, increase income when reinvested in production.

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Author: Charles Lutwidge

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