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What is Days Inventory Outstanding?

Days inventory outstanding measures the average number of days required for a business to sell its inventory. A low days of inventory figure is generally considered to represent an efficient use of the inventory asset, since it is being converted into cash within a reasonably short time. In addition, a short holding period allows little chance for inventory to become obsolete, thereby avoiding the risk of having to write off some portion of the inventory asset.

How to Calculate Days Inventory Outstanding

To calculate days inventory outstanding, divide average inventory by the cost of goods sold, and multiply the result by 365 days. The formula is calculated as follows:

(Average inventory / Cost of goods sold) x 365 Days

= Days inventory outstanding

The average inventory figure is used in the calculation, rather than the inventory balance on a specific date, because inventory levels can change significantly by day. The most common way to derive an average inventory figure is to take the average of the beginning and ending inventory balances for the measurement period. A more accurate option is to include in the average the ending inventory balance for every day of the measurement period.

Example of Days Inventory Outstanding

For example, a business maintains an average inventory of $300,000. Its annual cost of goods sold is $2,000,000. Based on this information, its days inventory outstanding is calculated as follows:

($300,000 Average inventory ÷ $2,000,000 Cost of goods sold) x 365 Days

= 54.75 Days inventory outstanding

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How to Interpret Days Inventory Outstanding

Days inventory outstanding (DIO) measures the average number of days it takes for a company to sell its inventory during a given period. A lower DIO indicates that inventory is being sold quickly, which is often a sign of strong demand or efficient inventory management. Conversely, a higher DIO suggests slower-moving inventory, which could point to weak sales, overstocking, or potential obsolescence issues. When interpreting DIO, it is important to compare it to industry benchmarks and historical trends for the company to determine whether the inventory turnover rate is healthy or needs improvement.

How to Reduce Days Inventory Outstanding

A business can improve its days of inventory metric by using a just-in-time production system. These systems are designed to only produce units when there are customer orders in hand; they are not designed to build to stock. They also minimize the amount of work-in-process, resulting in very low on-hand inventory counts. Another option is to promptly dispose of any inventory that does not sell well. This requires a constant analysis of sales levels for all finished goods items, with excess goods being dispositioned as soon as it becomes apparent that the firm cannot sell them directly. A third option is to accept more inventory stockouts by keeping fewer goods on hand. This represents a balance between annoying customers who have to wait for their deliveries, and shrinking the inventory investment.

FAQs

How does days inventory outstanding differ from inventory turnover?

Days inventory outstanding expresses inventory efficiency in terms of days, showing how long inventory is held before it is sold. Inventory turnover measures the same concept as a frequency, indicating how many times inventory is sold and replaced during a period. The two metrics are inversely related and convey similar information in different formats.

Related Articles

Average Age of Inventory

Days Sales in Inventory

Inventory Accuracy Formula

Inventory Turnover Formula

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