What is Days Inventory Outstanding (DIO)?
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 and is used to determine the liquidity of the company’s inventory. 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
- Average inventory = (Beginning inventory + Ending inventory) / 2
- Cost of Sales is also known as Costs of Goods Sold
Example of Days Inventory Outstanding
Company A sells several types of furniture. The manager would like to determine which brands of furniture are doing well in terms of inventory turnover and he’s tasked you with determining the days inventory outstanding for certain 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, the manager is able to 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 lagging behind. In this scenario, the manager may want to consult with his sales and marketing team to figure out how to sell Brands 1, 3 and 4 faster or if they should discontinue the brands 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.
In financial analysis, it is important to not compare DIO across industries. The DIO varies greatly according to the industry. For example, companies in the food industry generally have a DIO of 6 while companies operating in the steel industry have an average DIO of 50. Therefore, comparing DIO between companies in the same industry offers greater insight than comparing DIO between companies in different industries.
The 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 will last.
- DIO shows the liquidity of inventory. A short DIO means inventory is converted to cash quicker while a high DIO shows poor inventory liquidity.
- DIO should never be compared across industries, as the DIO varies greatly between different industries.
- A lower DIO is generally more favorable than a high DIO.
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