Measures how quickly a company utilizes the average inventory available at its disposal
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Days of Inventory on Hand (DOH) is a metric used to determine how quickly a company utilizes the average inventory available at its disposal. It is also known as days inventory outstanding (DIO) and is interpreted in a number of ways. Since it’s used to determine the number of days that the inventory remains in stock, the DOH value represents the inventory liquidity.
If a business is performing well, then it should report a low DOH, which indicates that it takes a short period to clear inventory.
The DOH is a very important measure for financial analysts and potential investors because it shows how capable a company is of managing its inventory efficiently.
Breaking Down Days of Inventory on Hand
By computing the Days of Inventory on Hand, a company is able to know just how long its cash remains tied up in its stock. As stated earlier, a smaller DOH means the company is performing better. Ideally, it means that the company is using its inventory more efficiently and frequently, which can result in potentially higher profit.
In contrast, a large DOH value shows that the company is struggling to clear its stock. If a company shows too much inventory, it can indicate that it’s invested poorly. However, a high-volume inventory is not all bad for businesses. It can be that the company is holding excess inventory so that it can meet sudden increases in demand, which happens a lot during peak seasons such as Christmas.
How to Calculate Days of Inventory on Hand
To make a product that can sell on the market, a company needs to invest in quality raw materials and other resources, all of which are a part of inventory. Obviously, the items come at a cost. Also, the company incurs additional costs in expenses related to the manufacturing process. They include labor and paying for utilities such as electricity. All the expenditures are recorded as the cost of goods sold (COGS) and are counted as the cost of manufacturing the products.
The Days of Inventory on Hand figure is computed by taking the COGS into account. More specifically, it consists of the average stock, COGS, and number of days. The formula is given as:
In other words, the DOH is found by dividing the average stock by the cost of goods sold and then multiplying the figure by the number of days in that accounting period. Note that the formula above divides the denominator by the number of days to generate the same result. The number of days is taken as 365 for a complete accounting year and 90 for a quarter.
There are two different techniques of accounting for average inventory. Some companies use the amount of inventory recorded at the end of the previous accounting period. Others find the average inventory by summing up its stock at the beginning and end of the period, then dividing the result by two. In summary:
Whether you use the first or second version, the cost of goods sold remains constant.
Consider retail giant Walmart Inc., which reported an ending inventory of $43.78 billion and cost of goods sold of 373.4 billion for the accounting period ending in 2018. Usually, the inventory is recorded in the statement of financial position (balance sheet), while the COGS is recorded in the annual financial statement.
When accounting for the inventory, it’s important to include all of the following categories:
Work in progress
Being a retailer, the only type of inventory Walmart holds is finished goods. Thus, its DOH will be:
In comparison, Microsoft Corp. (MSFT) posted an ending inventory of $2.66 billion and COGS at $38.97 billion at the end of its annual accounting period for 2018. However, unlike Walmart, Microsoft is not a retail company, so its inventory is distributed among raw materials ($655 million), work in progress ($54 million), and finished goods ($1.95 billion). Its DOH is calculated as:
From the calculations above, Microsoft Corp. shows a shorter period – about 25 days – to clear its stock, compared to 43 days for Walmart.
Key Takeaways – Days of Inventory on Hand
Days Inventory on Hand determines whether a company is managing its inventory in an efficient manner. Inventory takes up one of the largest portions of operational capital, so it’s crucial that it is managed wisely. By finding the number of days that a company holds its stock before selling it, the DOH metric determines the average duration that cash is tied up in inventory.
As seen in the examples, DOH varies significantly depending on several factors, such as the type of products manufactured and the business structure. Thus, when making comparisons, one should compare the values of similar, same-sector companies.
We hope you enjoyed reading CFI’s explanation of DOH. To keep learning and developing your knowledge of financial analysis, we highly recommend the additional CFI resources below:
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