Turning raw materials into finished products and selling the inventory at a profit— this is how most businesses operate. Your revenue and top-line gets affected if it takes longer for your business to sell the finished products. A higher DIO also results in slow cash flow and unused operational capacity.
Investors use DIO as a key metric to evaluate the strength of a business as it is a direct indicator of its potential to generate revenue. It also indicates how well a business manages its inventory and raw materials.
Analysts use DIO to determine a company’s sales efficiency. DIO also helps determine how to improve product pricing, sales, and marketing strategies, based on customer demand and spending patterns.
What is days inventory outstanding (DIO)?
Days inventory outstanding (DIO), also known as days sales of inventory (DSI), is the average number of days a company holds inventory before selling it. DIO tells you how quickly a company can turn its inventory into cash. It is a measure of a company's operational and financial efficiency as well as liquidity.
How to calculate days inventory outstanding? Formula & example
Businesses strive to minimize DIO to reduce the time it holds inventory.
Calculating a company's days inventory outstanding requires two inputs:
Inventory: On the balance sheet, inventory items represent the dollar value of a company's raw materials, work in process, and finished goods.
Cost of goods sold (COGS): On the income statement, COGS items represent the direct costs incurred by a business in selling goods and services to generate revenue.
The increase in working capital (current operating assets less current operating liabilities) reduces free cash flow when it represents an outflow of cash, such as in inventory.
Formula:
Example:
Let’s assume a leading retail corporation has inventory worth $56.5 billion and its cost of goods sold is $429 billion for the fiscal year 2022. It’s DIO is
DIO = (56.5/429) x 365= 48.1 days
The inventory value can be found on the company's balance sheet, while the COGS value can be found on the income statement. Businesses should be careful to include the total of all inventory categories including finished goods, work in process, raw materials, and prepayments.
Importance of days inventory outstanding
- DIO is a degree of stock control effectiveness and is utilized to control how long it takes to convert the current stock to sales/cash.
- DIO indicates inventory liquidity. A short DIO means that inventory is converted to cash faster, while a high DIO indicates less liquid inventory.
- A lower DIO is generally more favorable than a high DIO as it indicates a higher sales turnover.
What does a high or low days inventory outstanding signify?
A
low DIO can mean either one or more of the following:
- The company is effectively using its inventory by rapidly converting it to sales.
- The company is not storing enough inventory for the required demand, i.e. the company could be struggling to meet the sudden increase in demand.
High DIO may mean the following:
- The company is not able to translate its inventory into sales quickly.
- The company has been overstocking inventory, leading to higher storage costs and obsolete stock that might never sell.
How to improve days' inventory outstanding?
A low DIO indicates quick sales and lower inventory carrying costs, and hence is considered better for business operations. DIO can be reduced by accelerating inventory conversion to sales or by reducing the value of inventory held.
So, some strategies companies adopt to reduce DIO include :
- Increasing the accuracy of planning and forecasting to resolve any discrepancies between forecasts and actual sales. A more accurate sales forecast means you don't need to keep more inventory than you need.
- Increasing demand by deploying more effective marketing strategies.
- Accelerating the sales process by onboarding customers faster, shipping goods quickly, and sending accurate e-invoices. The faster a sale can be made; the sooner the inventory will be converted to cash.
- Optimizing inventory levels with techniques such as just-in-time delivery and preferred vendor partnerships.
How to interpret days inventory outstanding?
Benchmarking a company's inventory and DIO against peers provides valuable insights into their inventory management strategies. Average inventory turnover and DIO vary by industry; however, higher inventory turnover and lower DIO are generally preferred as it implies that inventory management is closer to an optimal state.
| High DIO: Reasons & Consequences |
Low DIO: Reasons & Results |
- There may not be enough demand for your product, or your price may be too high. You must reconsider your target audience.
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- You are efficiently managing your raw materials and have robust supply chain operations.
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- Your marketing strategy may be ineffective, resulting in lesser interest in your goods & services.
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- You have enough free cash flow available for investment and debt repayment purposes.
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- Your product may become obsolete and you need to provide significant price reductions to eliminate inventory.
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- Companies with low DIO can be overwhelmed if demand spikes; if inventory drops to zero, the business will miss out on sales.
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How can HighRadius help?
HighRadius offers autonomous order-to-cash solutions to automate processes such as invoicing, collections, and credit risk management. These help accelerate your sales cycle by enabling your sales personnel to onboard customers faster and process purchase orders quickly.
Check out our
Autonomous Receivables solution for more details.
