The average number of days before inventory before is sold
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Days inventory outstanding (DIO) is the average number of days that a company holds its inventory before selling it. The days inventory outstanding calculation shows how quickly a company can turn inventory into cash. It is a liquidity metric and also an indicator of a company’s operational and financial efficiency. Days inventory outstanding is also known as “inventory days of supply,” “days in inventory,” or “the inventory period.”
Days Inventory Outstanding Formula
The formula for days inventory outstanding is as follows:
Days Inventory Outstanding = (Average inventory / Cost of sales) x Number of days in period
Days in Period means the number of days in the period, such as an accounting period, that is being examined – the period may be any time frame – a week, a quarter, or annually
Example of Days Inventory Outstanding
Company A sells several brands of furniture. The manager would like to determine which brands are doing well in terms of inventory turnover. He’s tasked you with determining the days inventory outstanding for several different brands:
To determine the DIO of each brand:
DIO Brand 1: ($3,000 / $35,000) x 365 = 31.29 days
DIO Brand 2: ($1,000 / $40,000) x 365 = 9.13 days
DIO Brand 3: ($5,000 / $54,000) x 365 = 33.80 days
DIO Brand 4: ($1,500 / $20,000) x 365 = 27.38 days
From determining the DIO of each brand, you can easily see which brands are doing well relative to other brands. In this case, Brand 2 is doing extremely well, while Brands 1,3, and 4 are all lagging about equally behind. The manager may then meet with the sales and marketing team to try to figure out how to improve sales of those brands. The company might consider dropping Brand 3, the poorest performer, entirely.
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Interpretation of Days Inventory Outstanding
A low days inventory outstanding indicates that a company is able to more quickly turn its inventory into sales. Therefore, a low DIO translates to an efficient business in terms of inventory management and sales performance.
A high days inventory outstanding indicates that a company is not able to quickly turn its inventory into sales. This can be due to poor sales performance or the purchase of too much inventory. Having too much idle inventory is detrimental to a company as inventory may eventually become obsolete and unsellable. Holding excess inventory also negatively impacts cash flow.
In financial analysis, it is important to compare DIO with the DIO of similar companies within the same industry. For example, companies in the food industry generally have a DIO of around 6, while companies operating in the steel industry have an average DIO of 50. Therefore, comparing DIO between companies in the same industry offers a much better, more accurate and fair, basis for comparison.
Importance of Days Inventory Outstanding
DIO is a measure of inventory management effectiveness and is used by management to determine how long the company’s stock of inventory typically lasts – how long it takes to convert existing inventory to sales/cash.
DIO shows the liquidity of inventory. A short DIO means inventory is converted to cash more quickly while a high DIO shows poor inventory liquidity.
DIO should never be compared across industries, as the DIO varies greatly between industries.
A lower DIO is generally more favorable than a high DIO.
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