A Small Business Guide to Days Inventory Outstanding

Days inventory outstanding is a valuable and easy-to-calculate metric for your sales, inventory, and overall business health. Here’s how to find it and fold it into your decision-making.

Days inventory outstanding (DIO) is one of many critical business metrics that highlight the importance of inventory management in your larger operation. It’s another reporting tool with which to measure the overall health of your organization.

Determining your days inventory outstanding is critical for measuring the status of your sales and business health. Image source: Author

Using manual methods to determine days inventory outstanding and similar metrics can be quite taxing, which is a testament to the need for some level of inventory management software.

Continue reading to learn more about days inventory outstanding and what exactly it measures, how to calculate it, and where it fits in with other key business metrics.

Overview: What is days inventory outstanding?

Days inventory outstanding (DIO) refers to the average span of days it takes to sell all your inventory. The DIO inventory metric is also known as days sales in inventory (DSI).

Your DIO provides a quick snapshot of how quickly your business turns over inventory. It’s a similar metric to your average inventory turnover ratio. But whereas inventory turnover ratio provides the number of times you turn inventory over during a specified period of time, your DIO refers to the number of days for one complete turnover.

The value of your DIO depends on accurate inventory. Image source: Author

DIO finance implications include the effectiveness of allocated capital. If you have a high DIO measure, then your sales could be lagging, or you could be buying too much inventory at once.

It’s important to realize that your DIO doesn’t exist in a vacuum. With a low DIO, stock is selling quickly, and you can look to resupply, increase order quantities, or use your operating cash flow for other critical resources.

A high DIO most often correlates with negative business health. Resources mean more resources if properly allocated. So a high DIO means your resources are sitting dormant in inventory that’s not selling. But that isn’t always the case.

For example, if you get a great deal on a bulk purchase order and bring in a ton of inventory at once, that will skew your DIO higher but can also provide a favorable gross margin ratio.

On the flip side, a low DIO often signifies a healthy business that has consistent sales and optimal purchase orders. However, there are times when a low DIO isn’t a positive indicator.

For example, if you’re too risk-averse about purchasing a new product that ends up being super popular, you may have a truncated DIO but be unable to resupply and capture future sales on that popular product because your competitors took the initial risk on it.

Another concern with a low DIO is inventory shrinkage, which represents an unaccounted-for difference between on-hand inventory versus what the accounting records show. If there’s miscounted inventory, damaged or lost inventory, or theft, then that will skew the DIO lower but with an asterisk attached to the number.

The point of these examples is to highlight how important it is to realize the uniqueness of your business. Concepts such as DIO, profit margins, cost of goods sold, and accounts receivable are valuable ones on which to base your decision-making. But every business has nuances within each metric that are critical for owners and operators to understand.

How to calculate days inventory outstanding (DIO)

You should be relying on your inventory management software for critical measures such as DIO. It’s faster, removes human error, and offers a plethora of measures in easy-to-digest formats. But it’s still important for you and relevant team members to know how to calculate your DIO so that you understand what it’s saying conceptually.

There are multiple ways to interpret your DIO findings and plenty of aspects that can affect the meaning of the numbers. However, there’s only one formula for calculating your days inventory outstanding.

The days inventory outstanding (DIO) formula

Here’s how to calculate your days inventory outstanding:

DIO = (Average Inventory Value ÷ Cost of Goods Sold) x Number of Days in Period

Let’s break down that formula. First, there’s the average inventory value. There are two different ways to calculate the average inventory value that simply adjust the time span being measured.

There’s the metric “as of” a particular date, such as the end of the fiscal year, where the average inventory value is equal to the final inventory value as of the end date.

Then there’s the metric “during” a particular span of time, such as during the holiday season from November 1 to December 31, where the average inventory value is the sum of the beginning and ending inventory value divided by two.

Next is the cost of goods sold, which highlights the amount of resources invested in the inventory sold over a period of time.

The final component is the number of days in the time period in question. That’s most often 90 days for a quarter, or 365 days for a full-year annual review.

Example of days inventory outstanding (DIO)

If this explanation of the DIO formula is all you need, go forth and conquer. For the rest of us, here’s an example of what the DIO looks like and what it’s really telling us.

Let’s say you’re looking to purchase a retail business. You’ll definitely want to know the DIO for any business you’re considering. It’s also important to consider additional inventory categories, such as finished goods ready to sell (typical inventory) as well as inventory currently being manufactured, and raw materials needed for future inventory.

One business you’re eyeing, Retail1, has inventory worth $500,000 and a cost of goods sold worth $3.5 million for the fiscal year 2020. The business exclusively handles finished products that are ready for sale, so it has no raw materials or products currently being manufactured.

Considering an annual calculation, the DIO for Retail1 is as follows:

DIO = (Average Inventory Value ÷ Cost of Goods Sold) x Number of Days in Period

DIO = (500,000 ÷ 3,500,000) x 365

DIO = (1 ÷ 7) x 365

DIO = 52

This means it takes Retailer1 about 52 days on average to clear its inventory. What does that mean to you as a potential investor? It means that, at the current status quo, you can expect to sell out and restock on your inventory about twice per quarter. For a retail store, a DIO of 52 provides tons of agility and flexibility to try out new products and plan for seasonality.

Match DIO to Your Needs

Days Inventory Outstanding is a critical measure for your business. And more than most other metrics, you have to look at your DIO in the appropriate context. You want to see a DIO number that aligns with the nature of your products and your product goals.

This will take time to nail down, and it may be somewhat of a moving target that changes over time, given the unavoidable dynamics of your business and the retail space at large. That’s fine. Keep monitoring it and testing ways to tweak it for optimal and profitable results.