Days Inventory Outstanding (DIO)

What Is Days Inventory Outstanding (DIO)?

Days Inventory Outstanding refers to the financial ratio that calculates the average number of days of inventory that the company has held before selling it to the customers, thereby giving a clear picture of the cost of holding and potential reasons for the delay in selling inventory.

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The job of every company is to transform the inventory into finished goods. Without having the finished goods in hand, the company won’t be able to sell and make money. That’s why an investor needs to look at the days a company takes to turn its inventory into sales. It is a financial measure, and it tells the investor how good the company is in handling its inventory. In this article, we will look at this financial measure in detail.

Days Inventory Outstanding (DIO) Explained

The concept of days inventory outstanding explains the number of days that a business will hold its inventory with itself before selling it to the customers. The calculation of the same shows within what time period the stock will get converted into cash, which means how fast the business is able to sell off its goods and earn the revenue to be used within the entity.

A business is considered efficient and profitable if according to the days inventory outstanding calculation, it is able to convert the inventory stock to cash within a very limited timeframe. It means that it has a strong selling network, efficient allocation of resource to carry on the task and is able to collect the money on time which can be invested further for growth and expansion. This makes the business sustainable and profitable in the long run.   

It is necessary to have a sound and systematic inventory management practice which will help in controlling cost, initiate sales on time and also plan an efficient method of revenue collection without any delay. The supply chain management should be proper and an effective and transparent communication is required to make the process to be smooth.

Another name of “days inventory outstanding (DIO)” is “days sales of inventory (DSI).”

Days Inventory Outstanding tells us how many days a company takes to turn its inventory into Sales. For example, let us look at the graph above. Colgate’s DIO has been stable over the years and is currently at 70.66 days. However, when we compare this with Procter and Gamble, we note that P&G’s outstanding inventory has decreased over the years and is currently 52.39 days.

First, we will look at the formula, and then we will understand it further.

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Explanation Of Days Inventory In Video

Formula

Here’s the formula for days inventory outstanding calculation. Let us understand the concept in detail.

Days Sales of Inventory Formula = Inventory / Cost of Sales * 365

In the above formula, the cost of sales refer to the cost of goods sold, which is the cost that is associated with producing goods and services within the business, which can be direct, including the cost of raw materials and direct labor involved in producing the goods and also indirect with can be the cost incurred to distribute and sell them over to customers.

The number 365 in the calculation of average days inventory outstanding denotes the number of days in a financial year. However, the period an also be a week or a month or quarter, depending on the company policy.

Example

Let’s take an easy example of average days inventory outstanding to illustrate how the whole thing works.

Example#1

Company Zing has an inventory of $60,000, and the cost of sales is $300,000. Find out the day’s inventory outstanding of Company Zing.

All we need to do is to put the figure in the formula.

Here’s the formula –

Days Inventory Outstanding formula = Inventory / Cost of SalesCost Of SalesThe costs directly attributable to the production of the goods that are sold in the firm or organization are referred to as the cost of sales.read more * 365

Or, DIO = $60,000 / $300,000 * 365

Or, DIO = 1/5 * 365 = 73 days.

That means it takes 73 days to translate the raw materials into cash for Company Zing.

Example#2

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Airlines Sector

Below is the Inventory Days Oustanding of top companies in the Airline Sector

• Inventory processing days of the Airline sector are less than one month for most companies.
• Ryanair Holdings has the lowest inventory processing days of 0.33 days, whereas United Continental holding has inventory days outstanding of 23.33 days.

Automobile Sector

Below is the list of top companies in the Automobile Sector, along with its Market capMarket CapMarket capitalization is the market value of a company’s outstanding shares. It is computed as the product of the total number of outstanding shares and the price of each share.read more and inventory days outstanding.

Discount Stores

Below is the list of top companies in Discount Stores and their Market cap and outstanding inventory days.

• Burlington Stores has the highest Inventory Days Oustanding of 82.21 days, whereas, that of Wal-Mart Stores is 44.21 days

Oil & Gas Sector

Below is the list of top companies in the Oil & Gas Sector, along with its Market cap and inventory days outstanding.

Inventory days outstanding are varied for the Oil & Gas sector. On the one hand, Apache has inventory processing days of close to 4 months, whereas ConocoPhillips has inventory processing days of less than one month.

Interpretation

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As The Business:

There are three components in the cash conversion cycle.

The first one is days sales of inventory. The other two are days sales outstandingDays Sales OutstandingDays sales outstanding portrays the company's efficiency to recover its credit sales bills from the debtors. The number of days debtors took to make the payment is computed by multiplying the fraction of accounts receivables to net credit sales with 365 days.read more and days payable outstandingDays Payable OutstandingDays Payable Outstanding (DPO) is the average number of days taken by a business to settle their payable accounts. DPO basically indicates the credit terms of a business with its creditors. read more.

That means we can easily say that day sales of inventory are one of the cash conversion cycle stages, which translates raw materials into cash.

In the formula, we can see that the inventory is divided by the cost of goods sold. It helps us understand the proportion of raw materials in the total cost of sales. Then we multiply that proportion by 365 days, which allows us to see the proportion in terms of days.

As An Investor:

First of all, days inventory outstanding (DIO) is a measurement of the company’s performance in terms of inventory management.

So, if the day’s inventory outstanding of a company are low, it means two things –

• First of all, low DIO means that the company has been effectively using its inventory.
• Secondly, low DIO also may mean that the company has not been storing inventory for the required demand, or the company has been writing down the inventory values.

On the other hand, we also need to look at the high day’s inventory outstanding. High days inventory outstanding also means two things –

• High Days Inventory Outstanding means that the company has not been able to translate its inventory into sales quickly.
• It also may mean that the company has been keeping obsolete inventory.

Since both low and high days inventory outstanding can’t be interpreted separately, an investor needs to follow a few steps while interpreting the low or high DIO –

• First of all, the investor should also look at the other companies in a similar industry to see whether the DIO is also low or high in the case of the other companies in a similar industry. If yes, then take the next step; if not, the investor should look at other financial ratiosFinancial RatiosFinancial ratios are indications of a company's financial performance. There are several forms of financial ratios that indicate the company's results, financial risks, and operational efficiency, such as the liquidity ratio, asset turnover ratio, operating profitability ratios, business risk ratios, financial risk ratio, stability ratios, and so on.read more of the said company first.
• If the first step yields a similar result, the investor should look at other companies in a different industry to be sure. She can gather the information of other companies in other industries and then compute the DIO to determine whether similar companies in the other industries are also providing similar results.
• The point of all of this is to ensure whether the company in one particular industry is doing good or not. Looking at different companies under the same industry and different companies under different industries will give you a holistic perspective of the investor.
• Lastly, the investor should look at the other two ratios of the cash conversion cycleCash Conversion CycleThe Cash Conversion Cycle (CCC) is a ratio analysis measure to evaluate the number of days or time a company converts its inventory and other inputs into cash. It considers the days inventory outstanding, days sales outstanding and days payable outstanding for computation.read more as well as other financial ratios of the company she wants to invest in.

What Statements To Look At To Find Out The Days Inventory Oustanding?

If you are a new investor, it may seem difficult for you to find out the inventory and the cost of sales (or cost of goods sold).

That’s why it’s important to know certain aspects of Days Inventory Outstanding.

While calculating DIO, we usually take the ending inventoryEnding InventoryThe ending inventory formula computes the total value of finished products remaining in stock at the end of an accounting period for sale. It is evaluated by deducting the cost of goods sold from the total of beginning inventory and purchases.read more. Or else, we can also take the average of the beginning and the ending inventory. To find out the average, all we need to do is add up the beginning and ending inventory, and then we need to divide the total by two.

To find out the inventory (average or ending), we need to look at the balance sheet. So you will see something like “closing stock” in the balance sheetClosing StockClosing stock or inventory is the amount that a company still has on its hand at the end of a financial period. It may include products getting processed or are produced but not sold. Raw materials, work in progress, and final goods are all included on a broad level.read more.

For the cost of goods sold, you need to pull out the income statement of the companyIncome Statement Of The CompanyThe income statement is one of the company's financial reports that summarizes all of the company's revenues and expenses over time in order to determine the company's profit or loss and measure its business activity over time based on user requirements.read more. And then, you need to see the column under “sales.” You will find the item “cost of goods sold.” The difference between sales and cost of goods soldCost Of Goods SoldThe Cost of Goods Sold (COGS) is the cumulative total of direct costs incurred for the goods or services sold, including direct expenses like raw material, direct labour cost and other direct costs. However, it excludes all the indirect expenses incurred by the company. read more is the gross profit, which will be mentioned in the income statement.

Use these two and put them into the formula, and you would have the company’s days inventory outstanding (DIO).

The case about working capital

As an investor, you also need to keep in mind that whether the company has required working capitalWorking CapitalWorking capital is the amount available to a company for day-to-day expenses. It's a measure of a company's liquidity, efficiency, and financial health, and it's calculated using a simple formula: "current assets (accounts receivables, cash, inventories of unfinished goods and raw materials) MINUS current liabilities (accounts payable, debt due in one year)"read more at any given moment or not.

To do that, you can look at days inventory outstanding.

Let’s say that a company has low DIO, meaning it takes a long time to transfer inventory into cash. Now, what if the day’s inventory outstanding decreases! That means the days it takes to turn inventory into cash also decreases. It means the company would have more cash (since the DIO gets faster). As a result, the working capital of the company will also increase.

On the other hand, if DIO increases, the days it takes to turn inventory into cash also increases. So, in a nutshell, the company would have less cash. That means the condition of the company’s working capital will also deteriorate.

Days Inventory Outstanding Vs Inventory Turnover

The above are two different financial metrics that explains the concept of inventory management by the company in two different ways. Even though they are quite related, there are some important differences between them as follows:

• The days inventory outstanding ratio is that financial metric that helps the business to calculate the average number of days that it needs to sell off the entire inventory stock to its customers. But the latter is basically a calculation that helps in measuring the number of times a business will be able to sell its existing stock and then buy new stock again to sell it later.
• If the former is lower, it indicates that the inventory management system is very efficient and the stock is easily converted to cash, whereas the lower value of the latter indicates the the inventory is very slow moving and remains in the warehouse for a long time.
• Just the opposite is the case with high value for the days inventory outstanding ratio, which indicates an inefficiency in selling the old stock and a higher value of the latter indicates a fast movement of the goods from the inventory form to cash and then purchase of new inventory.
• From the above points it can also be derived that both the concepts are inversely related to each other. A high days inventory outstanding corresponds to a lower inventory turnover.

Therefore the above are some important differences between the two concepts. It is necessary to understand and interpret them clearly so that it is possible to evaluate the inventory management process of the company and accordingly plan out strategies and method to improve the same to ensure that there is minimum possible wastage and maximum cost control, which will ensure profitability.

Recommended Articles

This article is a guide to what is Days Inventory Outstanding. We explain the formula along with example, differences with inventory turnover & interpretation. You may also have a look at the below articles learn further –

• Days in Inventory Formula
• Days Working Capital Definition
• Inventory Control – Meaning
• Compare – Issued vs. Outstanding Shares