March 31, 2021 Growing & Complex Businesses en_US Learn how to use the days inventory outstanding formula to understand how efficiently your business converts inventory into cash in our complete guide from QuickBooks. What is Days Inventory Outstanding? | 2021 guide
Growing & Complex Businesses

What is Days Inventory Outstanding? | 2021 guide

By Ben Oliveri March 31, 2021

For companies that make or sell physical products, inventory is one of the biggest operating expenses that affects liquid asset availability. To stay competitive, it’s important to understand and track business performance metrics that drive revenue and business success.

Days inventory outstanding (DIO), also known as days sales of inventory (DSI), is one such metric. DIO is a measure of how efficiently a business converts inventory investment into cash. Measuring days inventory outstanding against past performance and industry benchmarks helps to avoid bloated carrying costs and inventory write-offs while maintaining cash flow.

Let’s dig into what this metric is and who can benefit from using it.

Why you should use the days inventory outstanding formula

Tracking DIO reveals how well a company is managing procurement, pricing, and promotions. It’s also a leading indicator for healthy cash flow.

A high DIO means inventory items are sitting in storage for a longer period of time. This represents stagnant assets and lower liquidity. With lower liquidity, businesses may need to borrow money to fund operations and find themselves building debt. This will negatively affect financial statements and can jeopardize the long-term viability of a company.

A lower DIO result is preferable because it indicates inventory is moving more quickly and contributing to a healthier level of working capital.

By regularly tracking DIO, your company can reap a number of operational and financial benefits:

  • Reduce overstock and stockout
  • Reduce risk of inventory shrinkage, depreciation, or expiration
  • Lower carrying costs
  • Improve order fulfillment rate and speed
  • Improve inventory planning

What is the days inventory outstanding formula?

The days inventory outstanding formula is a metric that measures the average number of days a company holds an item before it is sold.

To calculate DIO, choose a time period based on your sales cycle or accounting period, and use the following formula:

Days inventory outstanding = (Average inventory / Cost of goods sold) x (# of Days) 

The result indicates how efficient a company’s cash conversion cycle is. All companies that make or sell products can benefit from calculating DIO.

Wholesalers, retailers, and ecommerce stores use this formula to measure the number of days finished products are stored before they are pulled to fill sales orders. Manufacturers can use the formula in two ways. Like retailers, they can measure the storage days it takes before finished products are sold. They can also measure the number of days components or raw materials are stored until they are pulled into production. This helps ensure procurement matches production needs.

How does days inventory outstanding formula work?

Let’s break down the components of the DIO formula and look at a days inventory outstanding example to see how it all comes together.

The DIO calculation factors in three parts: average inventory, cost of goods sold (COGS), and the number of days in the cycle.

Average inventory

To get the average inventory, add the beginning inventory value of the period (usually quarterly or monthly) and the ending inventory value. Divide the sum by two.

Average inventory = (Beginning inventory + ending inventory) / 2

Cost of goods sold

Cost of goods sold (COGS), or cost of sales, measures how much a company spent to sell their goods. To find your COGS, add the beginning cost of inventory to the cost of additional supplies, materials, and services associated with inventory management. Then subtract the cost of inventory remaining at the end of the period.

COGS = (Starting cost of inventory + Purchases, labor, supplies) – Ending cost of inventory

Number of days in a cycle

DIO can be calculated at the increment of your choosing. Calculate annually, quarterly, monthly, or at a custom increment according to your sales cycle. More frequent calculations mean a richer data set to inform forecasts and procurements.

The DIO formula in action

Days inventory outstanding = (Average inventory / Cost of goods sold) X # of Days 

Let’s assume we’ve arrived at an average inventory value of $1000.

The COGS sold is $10,000.

We’ll take an annual measurement and use 365 days for our measurement period.

DIO = 1,000 / 10,000 X 365 = 36.5

The days inventory outstanding is 36.5 days. This indicates it took the company 36.5 days to convert its inventory investment into cash for the period analyzed.

Days inventory outstanding and inventory turnover rate

Inventory turnover rate is another useful metric to analyze how efficiently your business is managing inventory. Where DOI measures how quickly inventory is converted into liquid assets, inventory turnover ratio simply measures the number of times stock on hand is sold and replenished in the period analyzed.

Inventory turnover rate is essentially the inverse of days inventory outstanding. Hence, while a low DIO is desirable, a higher inventory turnover rate is the goal. A high turnover rate means you are able to get products out the door quickly.

A low inventory turnover rate suggests either weak sales or excess stock.

Effectively managing inventory turnover helps to reduce depreciation and shrinkage. Optimal turnover is especially important for food items and perishable goods that will have to be written off if they spoil.

How to start using days inventory outstanding analysis in your business

Days inventory outstanding can be calculated for the entire inventory value of your warehouse, or individual product lines. It’s good practice to do both.

Doing a macro measure once per quarter helps to reveal overall corporate finance health. Appropriate DIO rates vary by industry and product. In the food industry, for example, average DIO is only 6, while steel producers have an average DIO of 50 days. To get an idea of how you’re doing, check DIO calculations against industry benchmarks.

Micro DIO measures for individual product lines inform pricing, promotions, procurement, and product mix. If you find a higher DIO for a certain item within a product category, you will know to stock less of this item and instead favor items that keep cash flowing.

If you are ready to put the formula into practice at your business, take these three simple steps.

1. Set your time increment

Decide on the most appropriate increment of measurement for your business. Ideally, you will have annual projections and quarterly milestones to reference against. If you are just getting started, begin with an annual increment of measure and refine until you have a body of data that coincides with the length of a sales cycle.

2. Build or update a body of core metrics

To keep a pulse of your inventory operations, you’ll need an up-to-date library of core metrics. Reference previous balance sheets to uncover past performance. To arrive at your DOI and turnover rate, you first needed to find your COGS and average inventory value—include these in your dataset. Other core inventory metrics to track include:

3. Invest in inventory management software

Performing an inventory analysis manually may not be the best use of your time and resources. With a modern inventory management system that tracks inventory and orders in real-time, you can extend visibility across your supply chain. With a software tool like QuickBooks Enterprise, you can reference inventory data in an intuitive dashboard and benefit from reporting features for COGS, average inventory, inventory valuation, cash flow, and more. In addition, this fully-featured tool makes compiling income statements and required accounting reports a breeze.

Final thoughts

To stay competitive in a world of thin margins and market disruptions, companies need to carefully manage inventory levels to protect profits while meeting customer demand.

Keep track of inventory metrics like days inventory outstanding and inventory turnover is essential for business success. Establish your own benchmarks and measure performance against industry standards.

With the right tools and strategy, you can turn inventory management into a competitive advantage.

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