what dsi tells you
since dsi indicates the duration of time a company s cash is tied up in its inventory a smaller value of dsi is preferred a smaller number indicates that a company is more efficiently and frequently selling off its inventory which means rapid turnover leading to the potential for higher profits assuming that sales are being made in profit on the other hand a large dsi value indicates that the company may be struggling with obsolete high volume inventory and may have invested too much into the same it is also possible that the company may be retaining high inventory levels in order to achieve high order fulfillment rates such as in anticipation of bumper sales during an upcoming holiday season dsi is a measure of the effectiveness of inventory management by a company inventory forms a significant chunk of the operational capital requirements for a business by calculating the number of days that a company holds onto the inventory before it is able to sell it this efficiency ratio measures the average length of time that a company s cash is locked up in the inventory however this number should be looked upon cautiously as it often lacks context dsi tends to vary greatly among industries depending on various factors like product type and business model therefore it is important to compare the value among the same sector peer companies companies in the technology automobile and furniture sectors can afford to hold on to their inventories for long but those in the business of perishable or fast moving consumer goods fmcg cannot therefore sector specific comparisons should be made for dsi values special considerationsone must also note that a high dsi value may be preferred at times depending on the market dynamics if a short supply is expected for a particular product in the next quarter a business may be better off holding on to its inventory and then selling it later for a much higher price thus leading to improved profits in the long run for example a drought situation in a particular soft water region may mean that authorities will be forced to supply water from another area where water quality is hard it may lead to a surge in demand for water purifiers after a certain period which may benefit the companies if they hold onto inventories irrespective of the single value figure indicated by dsi the company management should find a mutually beneficial balance between optimal inventory levels and market demand dsi vs inventory turnovera similar ratio related to dsi is inventory turnover which refers to the number of times a company is able to sell or use its inventory over the course of a particular time period such as quarterly or annually inventory turnover is calculated as the cost of goods sold divided by average inventory it is linked to dsi via the following relationship d s i 1 inventory turnover 365 days dsi frac 1 text inventory turnover times 365 text days dsi inventory turnover1 365 daysbasically dsi is an inverse of inventory turnover over a given period higher dsi means lower turnover and vice versa in general the higher the inventory turnover ratio the better it is for the company as it indicates a greater generation of sales a smaller inventory and the same amount of sales will also result in high inventory turnover in some cases if the demand for a product outweighs the inventory on hand a company will see a loss in sales despite the high turnover ratio thus confirming the importance of contextualizing these figures by comparing them against those of industry competitors dsi is the first part of the three part cash conversion cycle ccc which represents the overall process of turning raw materials into realizable cash from sales the other two stages are days sales outstanding dso and days payable outstanding dpo while the dso ratio measures how long it takes a company to receive payment on accounts receivable the dpo value measures how long it takes a company to pay off its accounts payable overall the ccc value attempts to measure the average duration of time for which each net input dollar cash is tied up in the production and sales process before it gets converted into cash received through sales made to customers 