What is Days of Inventory on Hand (DOH)?
The 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 the 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 that a company is capable 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 than the others. Ideally, it means that the company is using its inventory more efficiently and frequently, which can result in potentially high 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 in the sector. However, a high-volume inventory is not all bad for businesses. It can be that the company is holding too much inventory so that it can meet high orders, which happen a lot during peak seasons like the holidays.
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 the inventory. Obviously, the items come at a cost. Also, the company incurs additional costs catering for the 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, cost of sales, and number of days. Its 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. The number of days is taken as 365 for a complete accounting year and 90 for a quarter of the period.
There are two different techniques of accounting for average inventory. Some companies use the amount of inventory recorded at the end of its accounting period. Others usually 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 the categories, which include:
- Raw materials
- Work in progress
- Finished goods
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 in 2018. However, unlike Walmart, Microsoft is not a retail company, so its inventory was 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 of about 25 days to clear its stock while Walmart spends about 43 days.
The 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’s utilized wisely. By finding the number of days that a company spends holding onto its stock before selling it, the DOH metric determines the average duration that its cash is tied up in inventory.
However, the performance indicator should be examined more closely. As seen in the examples, the DOH varies significantly depending on several factors like the type of products manufactured and the business structure. So, when making comparisons, one should compare the values of same-sector companies.
CFI is the official provider of the Financial Modeling and Valuation Analyst (FMVA)™ certification program, designed to transform anyone into a world-class financial analyst.
To keep learning and developing your knowledge of financial analysis, we highly recommend the additional resources below: