Why Days Sales in Inventory Matters
Companies can unlock value by reducing days sales in inventory. A lower days sales in inventory has a number of benefits:
• Shorter cash conversion cycle
• Lower inventory holding costs
• Ability to operate with narrow margins
Benefit #1
Reducing a company’s days sales in inventory shortens its cash conversion cycle. The cash conversion cycle, also known as the cash-to-cash cycle, is the sum of days sales in inventory (DSI) and days sales outstanding (DSO) minus days payable outstanding (DPO).
Cash Conversion Cycle = DSI + DSO – DPO
If a company can reduce days sales in inventory it can reduce the length of its cash conversion cycle, which means the company will need less capital to finance inventory.
Benefit #2
Reducing a company’s days sales in inventory also reduces inventory holding costs. It’s not free to hold inventory, as companies incur the cost of:
• Storing the inventory
• Insuring the inventory against loss from fire, storm, or shipwreck
• Safeguarding the inventory with security measures
• Paying property taxes on the inventory
Some inventory faces the risk of obsolescence, while other inventory is at risk of spoilage. Inventory may also be lost, broken, or stolen. These events can lead to inventory writedowns that reduce the company’s profit.
There is also the opportunity cost of holding inventory, as the capital tied up in inventory could have been put to use in other projects or invested in securities to earn a return.
Benefit #3
Reducing DSI also allows a company to achieve profitability with a low gross margin.
0:00 Introduction
0:08 3 benefits of reducing DSI
0:18 Cash Conversion Cycle
2:53 Lower Inventory Holding Costs
4:17 Ability to operate with narrow margins
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