1.What is Days Inventory Outstanding : Days inventory outstanding (DIO) is a metric that calculates average number of days taken by the company to turn its inventory into sales. That is, no.of days the average stock is taking to be sold/ inventory to be cleared as sales.
It is also known as average age of inventory.
DIO = (Average Inventory / Cost of Goods Sold) x Number of Days in the Period
Or
No. of days in the period/ Inventory stock turnover ratio
2. Numerator and Denominator:
Where,
1) Average Inventory = (opening Inventory + closing Inventory) / 2
In cases where the opening balance of the inventory may not be known, then closing balance of inventory may be considered as average inventory.
In case of firm dealing with seasonal goods, the average of monthly opening and closing stock may be considered.
2) Cost of goods sold also known as cost of sales.
COGS= Op. stock+ purchases (cost of direct material and components purchased) + Direct labour +Direct expenses + manufacturing OH (Direct and Indirect)- closing stock
(or)
Net Sales-Gross profit
*Selling and Administrative expenses are not assigned to a specific product and hence are not included in the cost of goods sold. Rather they are included in the expenses section of a company's income statement for determination of profit/loss.
3) Number of Days in the Period = The number of days in the reporting period (e.g. quarter or year or weeks)
3. What does it indicate:
Lower the Inventory days = shorter is the period that cash is tied up in the form inventory, consequently lower is the risk of stock becoming obsolete.
Higher the Inventory days = inventory at stock is not getting converted into sales quickly resulting in obsolete stock, which if not sold over time, has to be written off resulting in business loss.
Also, cash is tied up in inventory for longer period, which could ideally be used effectively for some other business purposes.
4. How to improve DIO:
Some techniques to improve DIO:
- Better forecasting of the product demand in the market
- Measures for Liquidation of old stock
- Re-evaluate pricing strategies especially when there’s consistent dip in sales
- Better marketing techniques to reach the market
- Implementing Just-in-time inventory management