With this DIO calculator (days inventory outstanding), you can easily calculate the time it takes for a company to turn its inventory into sales. DIO is a very effective metric when analyzing the effectiveness of a company.
This article will help you understand what is days inventory outstanding and how to calculate days inventory outstanding.
Furthermore, we will also demonstrate some days inventory outstanding examples. But, before we dive into it, let's make sure you understand the days inventory outstanding definition.
What is days inventory outstanding? Days inventory outstanding meaning
Days inventory outstanding, or DIO, is a measure of how quickly a company can turn its inventory into sales. The days inventory outstanding definition is the average time it will take for the company to sell its inventory to its customers or clients.
DIO is one of the most widely used activity ratios used to assess a company's operation. Together with such metrics as days sales outstanding (DSO) and days payable outstanding (DPO), the cash conversion cycle (CCC) can be calculated to assess how well a company can turn its raw materials into cash.
How to calculate DIO using the days inventory outstanding formula?
To understand how to calculate DIO, let's use a hypothetical company - Company Alpha - as the days inventory outstanding example.
Company Alpha reports the following information:
- Inventory in 2020: $500,000;
- Inventory in 2021: $750,000;
- Number of days in a fiscal year: 365; and
- Cost of goods sold in 2021: $6,500,000.
There are 4 steps needed to calculate DIO:
- Determine the average inventory
Inventories are the stocks of goods that are stored within a company before they are sold. The average inventory can be calculated using the formula below:
average inventory = (beginning inventory + ending inventory) / 2
In this example, the
($500,000 + $750,000) / 2 = $625,000.
- Determine the company's cost of goods sold
cost of goods soldcan be found in the annual reports of the company. It will usually be in the income statement, just below the revenue line item.
In our example, the
cost of goods soldfor Company Alpha is
- Determine days in the company's accounting period
For most companies, their accounting period is equivalent to their fiscal year. Usually, there are 365 days in a fiscal year, and therefore,
days in accounting periodcan be safely assumed to be
- Calculate DIO using the days inventory outstanding formula
The final step is to calculate the DIO. We can achieve this by using the following formula:
DIO = (average inventory / cost of goods sold) * days in accounting period
Using this formula, you can calculate the Company Alpha's
($625,000 / $6,500,000) * 365 = 35.096 days.
Why calculate the days inventory outstanding?
The single most important purpose of calculating DIO is to analyze a company's inventory management efficiency. The shorter the DIO, the more efficient the company's inventory management system is.
If the company's DIO is shorter than its peers, it means that it has a very efficient inventory management system. Hence, it can consider buying more stock to increase its revenue. Also, it is vital to make sure the DIO is not too short as this might cause stock shortages.
On the other hand, if the company's DIO is longer than its peers, it should consider improving its inventory management system. If the company doesn't pay more attention to its stock, those products may expire or become obsolete.
Last, but not least, it is worth noting that DIO does not give you the whole picture of the company's operation. It only shows you the speed at which the inventories are turned into sales. Hence, it is recommended to look at other activity ratios, such as DPO, to understand how fast the company is paying its suppliers, or DSO, which shows the speed at which the customers pay the company. Furthermore, the cash conversion cycle, which includes DIO, DSO, and DPO, can give you a more high-level picture of the company's operation.