Days Inventory Outstanding

Businesses use several methods to measure how efficiently and effectively they are operating. Most of these metrics reflect how quickly a business converts its efforts and investments into cash revenue.

Days Inventory Outstanding (DIO) is one of several accounting metrics that help a business measure its effectiveness in converting products and services to cash. As the name implies, it measures how long a business takes to convert its physical inventory into sales.

DIO is one of three measures that a business often utilizes to assess the larger process of generating cash. Collectively, they are referred to as the cash conversion cycle (CCC). This composite metric essentially examines how long it takes for a business to convert cash invested in purchasing materials and products into more cash generated as revenue from sales.

The CCC calculates the net aggregate time along three stages:

• Days Inventory Outstanding (DIO) is the first of the three stages. It quantifies how long a business takes to convert purchased inventory into sales.

• The second metric, Days Sales Outstanding (DSO), quantifies the average number of days it takes a business to collect payment for products and services sold.

• Finally, the Days Payable Outstanding (DPO) measures how long the business takes to pay off its purchases.

A lower CCC number indicates that the business efficiently converts its cash into more cash. In other words, it quickly and effectively converts its initial investment into revenue.

Similarly, a lower DIO is a good indicator.

A lower number reflects a shorter timeframe in which cash is tied up in inventory. It indicates a quicker turn-around time for the products or materials that compose inventory, and a lower risk that the items will become obsolete or less sellable while they sit on the shelves.

DIO is determined using a multi-step calculation formula.

In the first step, accountants divide the average (or ending) inventory balance by the cost of goods sold. The latter is a compound figure that includes several costs involved in producing goods, such as materials, labor, manufacturing, freight and shipping, and production.

The result of the first step in this calculation is a fraction that measures the approximate value of goods on the shelf as a proportion of the total investment in making those products.

In the second step, accountants multiply the result from the first calculation by the number of days in the year, or 365. This reveals the value of inventory measured in days. In simpler terms, it reveals how many day’s worth of inventory the company may have on the shelves over a one-year period.

The calculation can be represented as:

(Average inventory ÷ Cost of Goods Sold) × 365 Days = Days Inventory Outstanding

Businesses of all types utilize DIO to measure their effectiveness. For example, if a bicycle company has $2,000 worth of inventory and the cost of making those bicycles is $35,000, the company's DIO would be calculated in the following manner:

DIO = ($2,000 / $35,000) X 365 = .06 X 365 = 22 days

In this example, the bicycle manufacturer has, on average, about 22 days of inventory (unsold bicycles) in a given year.

DIO is an important metric that helps a business evaluate its effectiveness in converting inventory to sales. It is part of a larger metric that helps the business evaluate how well it converts invested cash into revenue.

The metric is important for many reasons. A higher number reveals that the business has a larger amount of inventory on hand in the accounting period under review.

This is typically interpreted to mean that the business is turning over (selling) its inventory at a slower pace, which is something that it should strive to improve. It is important for a business to convert inventory to cash as quickly and efficiently as possible.

This generates revenue that can be put back into the business to pay for ongoing operations, and to invest in continued productivity and growth.