As a business owner, it’s helpful to know how quickly you can move products. This information can help with financial modeling, sales projections, and inventory planning.
So, if someone asked you how long your products sit on the shelf before someone buys them, would you be able to answer it? Yes, if you’re tracking a metric known as days inventory outstanding.
But what is days inventory outstanding? And why should you track it? We’ll cover all that and more, so let’s dive in!
What Is Days Inventory Outstanding?
Days inventory outstanding (DIO) measures the average number of days your company holds onto inventory before selling it. It’s also known as Days Sales of Inventory (DSI).
For example, let’s say you own a hardware store, and your company’s days inventory outstanding is 35. That means it takes an average of 35 days to sell your new inventory. In other words, new products typically stay on your shelves for 35 days before they are sold.
Why Is Days Inventory Outstanding Important?
DIO is important because it can help you figure out:
- How quickly you turn your inventory into cash: In accounting, this is known as the cash conversion cycle (CCC). In general, you want a shorter cash conversion cycle because it means that you can efficiently turn inventory back into revenue which helps pay for expenses like payroll.
- Your business's liquidity: Your liquidity compares how much of your assets are in cash versus inventory or accounts receivable (unpaid invoices). If you have more cash on hand, your company is more liquid. But if your assets are in the form of inventory or accounts receivable, you have to sell them to receive cash. This means your company is less liquid. Being more liquid lowers the need for debt to keep the business operating, so you can avoid additional interest expenses.
- How to manage your inventory: Your DIO gives you an idea of how long it will take before you need to replace the products on your shelves. In other words, you can use DIO to maintain optimal inventory levels. You can also compare the DIO of different products or brands to see which items move faster than others. This helps you schedule orders from different vendors or even decide which products to sell more of than others.
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How Do You Calculate Days Inventory Outstanding?
The days inventory outstanding formula is:
Days inventory outstanding (DIO) = (Average inventory value / cost of goods sold) x Number of days in the period
- Average inventory value: (Beginning inventory + Ending inventory) / 2
- Cost of goods sold (COGS): Also known as cost of sales, it refers to expenses directly related to inventory, such as buying products from a manufacturer. If you manufacture your own products, it also includes the price of raw materials and any labor associated with producing the finished goods.
- Days in period: The number of days in the accounting period you’re calculating DIO for. For example, it’ll be 365 days for one year.
Where Can I Find this Information?
You can find your inventory value under the asset section of your balance sheet.
Let’s say you want to calculate DIO for the year 2022. Here’s where you will find the inventory information you need using financial statements.
- Beginning inventory: Your total inventory value on the balance sheet for Jan. 1, 2022
- Ending inventory: Your total inventory value on the balance sheet for Jan. 1, 2023
As for the cost of goods sold, that’s a line item you can find on your income statement. In this case, you would use an income statement that covers the period from Jan. 1, 2022 to Jan. 1, 2023.
Let's look at an example to see how this works in action.
Example: Calculating DIO for a Product
Say you own a hardware store and have the following inventory details for the year for a brand of paints you sell.
- Beginning inventory: $4,000
- Ending inventory: $2,000
- Cost of goods sold: $42,000
- Days in the period: 365
First, you calculate the average value of inventory using the following formula:
Average inventory = (Beginning inventory + Ending inventory) / 2
Average inventory = ($4,000 + $2,000) / 2 = $3,000
Next, calculate days inventory outstanding.
- DIO = (Average inventory / Cost of Goods Sold) x Days in the period
- DIO = ($3,000 / $42,000) x 365
- DIO = 0.0714 x 365 = 26.06
Your DIO is 26.06, which means it takes an average of 26.06 days to sell new products after you buy them.
Example: Comparing DIOs of Two Products
What if you want to compare the sales speed of different brands? To see how that works, let’s compare the DIO from the first example with another brand of paint.
We’ve already calculated DIO for the first brand. Let’s look at the second one.
|Metric||Paint Brand A||Paint Brand B|
|Cost of goods sold||$42,000||$35,000|
|Days in period||365||365|
To calculate DIO for Paint Brand B, we can use the formula:
- DIO = (Average inventory / Cost of Goods Sold) x Days in period
- DIO = ($2,000 / $35,000 ) x 365
- DIO = .0571 x 365 = 20.84
So, your two DIO metrics are:
|Metric||Paint Brand A||Paint Brand B|
What does that mean?
On average, products from Brand A spend 26.06 days on the shelf before being sold, while products from Brand B only spend 20.84 days on the shelf before someone buys them. In other words, Brand B has a lower DIO, meaning it tends to sell faster.
Is one better than the other?
Let’s dive into that.
Is It Better To Have High or Low Inventory Days?
Generally, it’s better to have a low DIO because it means you’re selling items faster and have a freer cash flow. A free cash flow means you have cash on hand to pay for expenses rather than having money tied up in your company’s inventory.
In contrast, a high DIO means it takes you longer to sell items after purchasing them. Instead of efficiently turning them into cash, your assets sit on the shelves longer.
What Is a Good Days Inventory Outstanding?
While DIO can vary between industries, it’s generally good to be between 30 and 60 days.
Tips To Improve Your Days Inventory Outstanding
To improve your inventory management, you can aim for a lower DIO and follow strategies that help you sell inventory faster or reduce the amount of inventory you’re holding at a time. Here’s how.
- Improve your inventory forecasting: You can use DIO to predict how long it will take to sell certain items. In addition, reviewing past sales data can help you identify trends, like seasonal popularity. This way, you know how much product to order, and you can avoid overstocking slower-moving items.
- Make smaller and more frequent inventory purchases: Small and frequent orders make it easier to adjust your purchase amounts based on how much you’ve recently sold. This strategy works well with the just-in-time (JIT) inventory method, which means you restock items right before you expect to sell them. This strategy requires good supply chain relationships. In particular, look for vendors you can trust to make deliveries on time so you don’t run out of stock.
- Reduce slow-moving products: Pause orders on your slow-moving products and use strategies like discounts to help get them off the shelves.
- Increase customer demand: You can use marketing strategies like discounts and content marketing to increase the popularity of your products and help them sell faster. For instance, hardware stores can share DIY tutorials that feature their products. Highlighting various ways your products can be used by customers can lead to more demand.
What Is the Difference Between Inventory Turnover Days and Days Inventory Outstanding?
Inventory turnover is a financial ratio that measures how many times you completely sell out of all your products during the year, while days inventory outstanding tells you how long products sit on the shelf before they’re sold.
Let’s compare the two using Paint Brand A to get a better idea of the difference.
|Paint Brand A|
|Cost of Goods Sold||$42,000|
|Days in Period||365|
|Days Inventory Outstanding||26.06|
|Inventory Turnover Ratio||?|
The formula for inventory turnover is:
Inventory Turnover Ratio = Cost of goods sold / Average inventory
Inventory Turnover Ratio = $42,000 / $3,000 = 14
An inventory turnover ratio of 14 means you sold out of Paint Brand A and had to fully restock it 14 times during the year.
In contrast, the days inventory outstanding of 26.06 means that products from Paint Brand A stay in your store for 26.06 days before they sell.
Is a High or Low Inventory Turnover Ratio Better?
In general, it’s better to have a higher inventory turnover ratio. This means you sell out of your products more during the year, and it suggests that you’re more efficient at turning products into revenue.
Understand How Fast You Sell Items
Days inventory outstanding (or days sales of inventory) is a measurement you can use to understand how fast you can sell items.
If you have a low DIO, it shows you’re more efficient at selling products and turning your inventory into revenue. On the other hand, a higher DIO means your company’s assets are tied up in unsold products, and it takes you more time to convert them into cash.
You can lower your products’ days in inventory outstanding by ordering less of your slow-moving products, using marketing strategies to increase demand, and creating more accurate sales forecasts. When done right, you’ll be able to sell items faster and improve your company’s cash flow.