What is Days Inventory Outstanding?
Days Inventory Outstanding (DIO) measures the number of days it takes on average before a company needs to replace its inventory.
DIO is often measured to improve a company’s go-to-market, sales & marketing, and product pricing strategies based on historical customer demand and spending patterns.
How to Calculate Days Inventory Outstanding (Step-by-Step)
DIO, or “days inventory outstanding”, measures the number of days required for a company to sell off the amount of inventory it has on hand.
Thus, companies attempt to minimize their days inventory outstanding to limit the time that inventory is sitting in their possession.
In order to compute a company’s days inventory outstanding, two inputs are necessary:
- Inventory: On the balance sheet, the inventory line item represents the dollar value of the raw materials, work-in-progress goods, and finished goods of a company.
- Cost of Goods Sold (COGS): On the income statement, the COGS line item represents the direct costs incurred by a company while selling its goods or services to generate revenue.
An increase in an operating working capital asset, such as inventory, represents an outflow of cash, which is why in the free cash flow formula, an increase in working capital (i.e., current operating assets minus current operating liabilities), results in a reduction in FCFs.
If the inventory balance increases, that means more cash is tied up in the operations of the business, as it is taking longer for the company to sell and get rid of its inventory than it is to produce it.
Days Inventory Outstanding Formula (DIO)
The formula for calculating DIO involves dividing the average (or ending) inventory balance by COGS and multiplying by 365 days.
Conversely, another method to calculate DIO is to divide 365 days by the inventory turnover ratio.
What is a Good Days Inventory Outstanding (DIO)?
A comparative benchmarking analysis of a company’s inventory turnover and DIO relative to its industry peers provides useful insights into how well inventory is being managed.
The average inventory turnover and DIO varies by industry; however, a higher inventory turnover and lower DIO is typically preferred as it implies the management of inventory is closer to an optimal state.
In addition to being an indicator of ordering and inventory management efficiency, a high inventory turnover ratio and low DIO means higher free cash flows.
That is why the inventory turnover ratio and days inventory outstanding (DIO) are valuable metrics to track for companies, especially those selling physical products (e.g., retail, e-commerce).
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