Days Inventory Outstanding
The typical number of days a company maintains its inventory before selling it.
What is Days Inventory Outstanding (DIO)?
Days inventory outstanding (DIO) refers to the typical number of days a company maintains its inventory before selling it. How quickly a firm can turn inventory into cash is shown by computing the day's outstanding inventory.
It evaluates the operational and financial efficiency of a company and analyzes liquidity. Other names for days inventory outstanding include Days In Inventory (DII), Days Sales of Inventory (DSI), days in inventory supply, and the inventory period.
A crucial financial measure for any firm with inventory is the days' inventory outstanding ratio, which is defined as an indicator of inventory turns.
Based on past consumer demand and purchasing trends, DIO is frequently assessed to enhance a company's go-to-market, sales & marketing, and product pricing strategies.
Key Takeaways
- Days Inventory Outstanding (DIO) represents the average number of days a company holds inventory before selling it.
- Lower DIO is preferred, signaling efficient inventory use and quick turnover. Higher DIO may suggest inventory management issues like overstocking or poor sales.
- Lower DIO indicates efficient inventory use and potential for higher profits. Higher DIO may signal challenges in inventory management, impacting productivity.
- DIO should be interpreted in the context of the industry standards and alongside other financial ratios.
Understanding Days Inventory Outstanding (DIO)
Days Inventory Outstanding demonstrates the speed at which management may convert inventories into cash. Generally speaking, a decline in DIO indicates an improvement in working capital because it converts to cash in a reasonable amount of time, whereas an increase indicates a decline.
A company's inability to swiftly convert its inventory into sales is indicated by a high number of days of inventory outstanding. Poor sales results or the procurement of excessive inventory may be to blame in these cases.
A corporation should avoid having excess idle inventory since it might someday become unusable and outdated. Keeping too much inventory also has a detrimental effect on cash flow.
Additionally, a brief holding time reduces the likelihood that inventory will become outdated, lowering the possibility that the inventory asset would need to be written off as a whole.
Comparing the DIOs of comparable organizations within the same industry is crucial when doing financial research. For instance, businesses working in the food sector often have a DIO of roughly 6, but businesses in the steel sector typically have a DIO of 50.
As a result, comparing DIO among businesses in the same industry provides a far better, more accurate, and fair comparative base.
For example, let's say company A has a DIO of 67 days, and company B has a DIO of 58 days. This means that Company B sold all its stock in the inventory in 58 days, which is faster than Company A, with 67 days.
Days Inventory Outstanding Formula and Example
The Days Inventory Outstanding is a financial ratio represented by the following formula:
DIO = ( Avg Inventory / COGS ) x No. of Days
Where
- DSI: Days Sales of Inventory
- Avg Inv: Average Inventory = [(beginning inventory + ending inventory)/2] or Average inventory = ending inventory in some cases
- COGS: Cost of Goods Sold, also known as Cost of Sales
To illustrate, suppose firm A has a $4,000 average inventory, $27,000 cost of goods sold, and a period of 365 days. Whereas firm B has $7,300 beginning inventory, $2,000 ending inventory, $35,000 cost of goods sold, and a period of 365 days. Which company has a better DIO?
DIO A = (4,000/27,000) x 365 = 54.07 days
To find the DIO for firm B, we have to compute the average inventory first:
Average inventory = (7,300 + 2,000)/2 = $4,650
DIO B = ( 4,650/35,000) x 365 = 48.49 days
Therefore, firm B performs better than Firm A in days in inventory (DII).
You can quickly evaluate which companies are performing well in comparison to other companies by calculating the DIO of each.
Here, firm B is doing incredibly well while firm A is struggling. The manager may then arrange a meeting with the sales and marketing staff to discuss ways to boost the company's sales.
Below there's a video showing another example for Days to Sell Inventory.
Interpretation of Days Inventory Outstanding (DIO)
A lower value of Days Inventory Outstanding is desired since it shows how long a company's cash is locked up in its inventory.
A lower figure suggests that a business is using its inventory more effectively and often, which results in quick turnover and the possibility of higher earnings (assuming the sales being made are resulting in profit).
On the other hand, a high value of Days Inventory Outstanding number suggests that the business may be having trouble managing its high-volume, outmoded inventory and may have overspent on it.
To attain high order fulfillment rates, the business could also be holding onto significant quantities of inventory, perhaps in preparation for brisk sales throughout the next season.
DIO is a metric used to assess a company's inventory management efficiency. The operating capital needs of a firm include a sizable portion of the inventory.
This efficiency ratio determines the average period of time a firm's cash is locked up in the inventory by counting the days a company keeps the inventory until it sells.
This statistic should be carefully considered, though, as it frequently lacks context. Depending on several variables, including product type and company approach, DIO tends to vary significantly among sectors. The value of the firms in the same industry should thus be compared.
Businesses that deal in perishable or Fast-Moving Consumer Goods (FMCG) cannot afford to keep onto their inventory for as long as companies in the technology, automotive, and furnishings industries. As a result, DSI comparisons should be made within a sector.
Days Inventory Outstanding (DIO) vs. Inventory Turnover
A ratio similar to DIO is inventory turnover, which gauges how frequently a company may sell or utilize its inventory over a given time period, such as quarterly or annually.
Inventory turnover is calculated by dividing the cost of sold goods by the average inventory. It is related to DIO in the following ways:
DIO = (1/ inventory turnover)×365 days
Where,
Inventory Turnover = COGS / Inventory
For example, a company has an inventory worth $426,287 and a COGS of $4,738,216. What is the inventory turnover? What are the day's sales in inventory? How long, on average, did a unit of inventory sit on the shelves before it was sold?
Inventory turnover = COGS / Inventory
Inventory turnover = $4,738,216/$426,287
Inventory turnover = 11.12 times
Days' sales in inventory = 365 Days / Inventory Turnover
Days' sales in inventory = 365/11.12
Days' sales in inventory = 32.82 days
On average, the company's unit of inventory sat on the shelves for 32.82 days.
Below there's a video showing another example of how to calculate inventory turnover.
Interpreting Inventory Turnover
DIO is essentially the inverse of inventory turnover over a specific time period. Lower turnover and higher DIO go hand in hand.
In general, a higher inventory turnover percentage is better for the business since it means more sales are being generated. High inventory turnover will also occur if the inventory is lower and revenues are the same.
Even with a high turnover ratio, a company may occasionally experience sales declines if the demand for a product exceeds the inventory on hand. This confirms the need for contextualizing these numbers by contrasting them with those of industry competitors.
The first step in the three-step cash conversion cycle (CCC), known as the demand side integration, is the conversion of raw materials into realizable cash from sales. Days Sales Outstanding (DSO) and Days Payable Outstanding (DPO) are the remaining two phases.
The DPO value indicates how long it takes a firm to pay off its accounts payable, whereas the DSO ratio shows how long it takes a company to receive payment on accounts receivable.
In general, the CCC value aims to quantify the average amount of time that each net input dollar (currency) is tied up in the manufacturing and sales cycle before it is turned into cash earned through client sales.
Why does Days Inventory Outstanding (DIO) Matter?
The majority of firms must control their inventory levels, but those that operate in retail or who sell tangible goods have this duty in particular.
The inventory turnover ratio is one of the best measures of a company's level of efficiency at turning over its inventory and generating sales from that inventory.
However, the Days Inventory Outstanding ratio goes a step further by setting that figure into a daily context and providing a more accurate picture of the company's inventory management and overall efficiency.
By comparing the Days Inventory Outstanding and Inventory Turnover ratio to those of competitors, investors can ascertain if a company can effectively manage its inventory.
Stocks of companies with high inventory ratios frequently do better than the industry average. A stock with a higher gross margin than expected may provide investors an edge over rivals due to the surprise.
Inversely, a low inventory ratio may be a sign of overstocking, a lack of available products or markets, or other signs of poor inventory control. All of these issues are often detrimental to a business's overall productivity and performance.
or Want to Sign up with your social account?