Days inventory outstanding (DIO) is a working capital management ratio that measures the average number of days that a company holds inventory for before turning it into sales. The lower the figure, the shorter the period that cash is tied up in inventory and the lower the risk that stock will become obsolete. Days inventory outstanding is also known as days sales of inventory (DSI) and days in inventory (DII).
The CCC can therefore be optimized (reduced) in three different ways: by reducing DIO, reducing DSO or increasing DPO.
Days inventory outstanding formula
Days Inventory Outstanding is usually calculated as follows:
DIO = average inventory/cost of goods sold x number of days
Average inventory is the average value of inventory – companies may use the value of inventory at the end of a reporting period, or the average value of inventory during the period
Cost of goods sold is the cost of producing products sold during the period, including the cost of raw materials, labor and utilities
Number of days is the number of days in the period, i.e. 365 days for a year or 90 days for a quarter
Days inventory outstanding example
For example, if a company has $27,000 in inventory on average during a one-year period, and the cost of goods sold is $243,000, the DIO will be calculated as follows:
DIO = 27,000/243,000 x 365
= 40.56 days
Inventory turnover ratio
Related to DIO is the inventory turnover ratio, which calculates how many times a company sells and replaces its inventory during a given period of time. Inventory turnover can be calculated as follows:
Inventory turnover = cost of goods sold/average inventory
So for the company in the example above, inventory turnover would be calculated as:
Inventory turnover = 243,000/27,000
DIO can also be calculated as:
DIO = 1/inventory turnover x number of days
So in this example:
DIO = 1/9 x 365
= 40.56 days
What does a high or low days inventory outstanding mean?
Typical DIO can vary considerably between industry sectors. By comparing a company’s DIO with other companies in the same sector, it may be possible to draw some conclusions. What does a high DIO vs a low DIO mean?
If a company has a high DIO, it is not converting inventory into sales quickly, and may therefore not be managing inventory effectively compared to others within the sector. If DIO is high, the company’s cash is tied up in inventory for a longer period, meaning it cannot be deployed for other purposes. A high DIO may also be associated with overstocking, leading to higher than necessary storage costs and a high level of obsolete stock that may never be sold.
If a company has a low DIO, it is converting its inventory to sales rapidly – meaning working capital can be deployed for other purposes or used to pay down debt. If the company has a low DIO, there is also less chance that stock will become obsolete and have to be written off. However, a low DIO might also indicate that the company could struggle to meet a sudden increase in demand.
Conclusions can likewise be drawn by looking at how a particular company’s DIO changes over time. For example, a reduction in DIO may indicate that the company is selling inventory more rapidly in the past, whereas a higher DIO indicates that the process has slowed down.
How to improve days inventory outstanding
As a rule of thumb, a lower DIO is seen as more favorable than a higher DIO. DIO can be reduced by speeding up the conversion of inventory into sales, or by reducing the value of inventory held. As such, some strategies that businesses can adopt in order to reduce their DIO include the following:
Increasing the accuracy of planning and forecasting to address any mismatch between predicted and actual sales. The more accurately you can forecast sales, the less need there will be to keep a higher than necessary level of inventory
Increasing demand by deploying more effective marketing strategies
Speeding up the sales process – the faster a sale can be made; the sooner inventory will be converted into cash
Optimizing stock levels using techniques such as just-in-time delivery
Disposing of obsolete or slow-selling inventory, for example by offering discounts or free shipping
That said, a high DIO is not always problematic. Some companies may actively choose to keep higher levels of inventory – for example, if a significant increase in customer demand is expected. Another consideration is that some types of business will see seasonal fluctuations in demand for products, meaning that DIO may vary at different times of the year.