Days Inventory Outstanding (DIO) is a financial metric concerned primarily with working capital. It measures the average number of days that a company holds inventory prior to a sale. Thus, the lower the number, the fewer days that it takes to sell inventory. Days Inventory Outstanding (DIO) is also known as Days Sales of Inventory (DSI) and Days In Inventory (DII).
How is Days Inventory Outstanding Calculated?
DIO = average inventory / cost of goods sold x number of days
(/ = divided by, x = multiplied by )
Where average inventory is the money value of the entire inventory that can be taken from either the end of a reporting period, or it can be an average value for the period under scrutiny (in this case 1 year).
Where the cost of goods sold is the price to make the inventory items. Costs in this category include the price of raw materials, wages and utility bills.
Where the number of days is the time frame under consideration. This is often 365 days or 90 days (one quarter).
Therefore, if a company has an average inventory over a year of £50,000, and the cost to manufacture the inventory is £190,000. The DIO is calculated as:
50,000 / 190,000 x 365 = 96 Days
What is a Good DIO Number?
In the above example, it takes on average 96 days for inventory to be sold. This might seem poor. It depends: if your company only needs to sell a few items a year to be profitable, then 96 days as DIO might indicate financial health for the company.
In other words, to understand whether your company is holding too much stock for too long it is necessary to compare with other companies in the same sector.
High DIO
If in comparison to other companies in your sector, your DIO is high this indicates cash is being tied up in inventory for too long. This affects workflow capital. Reasons could be overstocking or poor sales. The danger of holding inventory for long periods is that the market could move on, leaving certain inventory items obsolete, non-compliant or out-dated.
Low DIO
Again, if a company DIO is low compared to that of other companies in the same sector, it indicates a company is performing well. Money is not being held captive; it is money that is quickly being released to working capital where it can be put to work.
However, a single digit DIO might indicate a structural weakness in a company. If on average inventory is held for less than 10 days then a sudden surge in demand might catch the company unaware and unable to fulfil orders on time.
That is why it is important to look at how DIO changes over time and to correlate the figures with the larger context of other economic factors such as economic upturns/downturns and changes in technology.
How to Improve Inventory Management
Days Inventory Outstanding can be reduced by the following methods:
- Better marketing to sell inventory quicker
- Better planning and forecasting to predict sales more accurately and match that with planned production
- Optimising stock levels so that a company never holds more inventory of raw materials and components than necessary. This method has been effectively used in the automobile industry using ‘just-in-time’ supply chains.
- Remove obsolete or slow-selling inventory by offering discount prices or other buying incentives such as free shipping
The Cash Conversion Cycle
Days Inventory Outstanding is an important metric in itself. However, it is also used to calculate a number for the cash conversion cycle. The formula for this is:
Cash conversion cycle = Days Inventory Outstanding (DIO) + Days Sales Outstanding (DSO) – Days Payable Outstanding (DPO).
The cash conversion cycle formula produces a number for days that shows how quickly money is being spent on raw materials etc., being turned into inventory, being sold and then reappearing as cash available. The faster money is being used to make inventory and then being realised in sales, the better it is for a company.
In Summary
Days Inventory Outstanding is a very useful metric for measuring the financial health of a company. The number needs to be put into the context of how other firms in the same sector are faring in terms of DIO.
If a company decides it is holding inventory for too long there are a number of actions available to reduce DIO.
And finally, DIO is a key component for calculating the value of the cash conversion cycle.
