Day 10 of Fundamental Investing
Continuing ahead with our Efficiency Ratio, the last one here is Day's Sales in Inventory Ratio.
What is it?
The day's sales in inventory calculation, also called days inventory outstanding or simply days in inventory measures the number of days it will take a company to sell all of its inventory. In other words, the day's sales in inventory ratio show how many days a company’s current stock of inventory will last. This is important to creditors and investors for three main reasons. It measures value, liquidity, and cash flows.
Older, more obsolete inventory is always worth less than current, fresh inventory. The day's sales in inventory show how fast the company is moving its inventory. In other words, it shows how fresh the inventory is. This calculation also shows the liquidity of inventory. Shorter days inventory outstanding means the company can convert its inventory into cash sooner. In other words, the inventory is extremely liquid.
How to calculate it?
Here's an image for the same:
What's its significance?
The day's sale in inventory is a key component in a company’s inventory management. Inventory is expensive for a company to keep, maintain, and store. Companies also have to be worried about protecting inventory from theft and obsolescence. Management wants to make sure its inventory moves as fast as possible to minimize these costs and to increase cash flows. Remember the longer the inventory sits on the shelves, the longer the company’s cash can’t be used for other operations.
Management strives to only buy enough inventories to sell within the next 90 days. If inventory sits longer than that, it can start costing the company extra money. It only makes sense that lower days inventory outstanding is more favourable than higher ratios.
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