Days Inventory Outstanding is a financial ratio that indicates the average number of days it takes a company to sell its inventory.
Product based businesses work in cycles of inventory movement.
The cycle starts with buying inventory at cost from a supplier. This inventory is then stocked in warehouses and retail shelves and eventually sold to a customer.
The average number of days it takes a business to complete this cycle once is called Days Inventory Outstanding.
The Days Inventory Outstanding is also often referred to as Days Inventory or Days Sales of Inventory.
Days Inventory = (Average Inventory / COGS) x 365
Average Inventory= (Beginning inventory + Ending inventory)/2. The Average Inventory is measured at cost and both the Beginning and Ending Inventory figures can be found in the Balance Sheet.
The COGS figure can be found in the Income Statement.
Let's say that SUPERPOWER INC. has $5,000 worth of average inventory and $25,000 of COGS times in a one year period; the Days Inventory figure would be
DIO = ($5,000 / $25,000) x 365 = 73 Days.
Since the Revenue of a business has a direct correlation with the sale of inventory, any lag in the Days Inventory figure could mean that the revenue of the company will slow down.
The Days Inventory figure is especially useful when you compare it with another period.
Ideally, businesses prefer the Days Inventory figure to keep falling since it means that inventory is selling faster.
An increase in the number of Days Inventory may be seen as a red flag by analysts and investors and needs to be further investigated by management.
Let's say the Days Inventory figure of 73 stated above goes to 93 over a two year period.
Management needs to ask questions such as
Why has the number of days it takes to sell inventory increased?
Is it a macro level factor, such as a slow down in the economy?
Does it have something to do with something inside the company?
Based on their investigation, management may come up with a slew of issues such as - There could be a problem with logistics OR inventory sales at the retail store may have slowed down (For example, in a Fashion business, it could mean that the designs are getting obsolete.)
Once the root cause of the issue is identified, management can take steps to address it.
For a full breakdown of other ratios that are useful in understanding the inner workings of a business, you can read our article on Ratio Analysis.
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