For growing businesses that make or sell physical products, inventory is one of the biggest operating expenses that affect liquidity. To stay competitive in the market, it’s important to understand and track business metrics that measure inventory efficiency and provide cash flow insights.
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 dead stock while maintaining cash flow.
Let’s dig into how DIO works 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. This represents slow-moving inventory and lower liquidity. With lower liquidity, businesses may need to borrow money to fund operations and find themselves building debt. This can negatively affect financial statements and jeopardize a company's long-term viability.
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 several 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 goods 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 before finished products are sold. They can also measure the days components or raw materials are stored until they are pulled into production. This helps ensure procurement matches production needs.
How does the 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 rate 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 can get products out the door quickly.
A low inventory turnover rate suggests either weak sales or excess inventory.
Effectively managing inventory turnover helps to reduce depreciation and shrinkage. Optimal turnover is significant for food items and perishable goods that will have to be written off if they spoil. With this in mind, QuickBooks Enterprise allows you to assign expiration dates to inventory, which can help teams take action on soon-to-expire items and reduce losses.
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. To understand 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. 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:
- Average inventory usage/sales
- Average inventory lead time
- Safety stock
- Inventory carrying costs
- Order fill rates
- Days sales outstanding
3. Track inventory accurately with an automated solution
QuickBooks Enterprise tracks inventory in real-time across warehouses down to the specific bin or pallet with intuitive, multi-level categorization. This is to ensure your team has the visibility to see what inventory is on hand or on order while automatically calculating which items need to be restocked based on set reorder points.
With accurate tracking, Enterprise’s built-in, customizable reports offer clear visibility into the value of your inventory and company cash flow, enabling your team to make more informed operations decisions.
Final thoughts
To stay competitive in a world of thin margins and market disruptions, growing businesses 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.
