Days Inventory Outstanding - Explained
What is Days Inventory Outstanding?
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Table of ContentsWhat is Days Inventory Outstanding?How does Days Inventory Outstanding Work? Calculating the Days Inventory OutstandingAcademic Research on Days Inventory Outstanding
What is Days Inventory Outstanding?
Days inventory outstanding, also known as days sales of inventory, days inventory, days cover or stock cover, is an efficiency ratio representing the average number of days worth of products remain in the inventory of a company before being sold. It is the average number of days a company takes to sell all the goods from its inventory including the products under the process of making. It can be expressed in different ways and the figure indicates the number of days the company needs to finish all the products stored in its inventory.
Back to: ACCOUNTING, TAX, & REPORTING
How does Days Inventory Outstanding Work?
The average days inventory outstanding depends on the nature of the product and the industry. In general, a lowers number is preferred as it indicates the funds are tied up in the company's inventory for a shorter period of time. Generally, a lower number than the industry norm indicates the company's inventory is being sold out more frequently leading to a higher profit. A higher number, on the other hand, indicates the products are piling up in the company's inventory involving a large investment.
Calculating the Days Inventory Outstanding
The formula of computing the days inventory outstanding is DIO = Average inventory/ (costs of goods sold/days) Here, the costs of goods sold include, the cost of the raw materials and other resources which forms the inventory and the labor and other utility costs. It is the total cost of manufacturing the products. The DIO is calculated considering the costs of goods sold during that particular period or as of a given date. In this calculation, the denominator indicates the average cost of producing the goods per day and the numerator is the valuation of the inventory.
There are two different ways the DOI is calculated, in one version the average inventory is calculated based on the reported figure at the end of an accounting period, in the other version the average value of Start Date Inventory and End Date Inventory is considered. In the first version, the DOI is expressed as a value as of the mentioned date while in the second version the DOI value represents the value during that period.
So, the Average Inventory could be equal to the end inventory or it could be, Average inventory= (Current inventory + Previous inventory)/2 depending on the method of computing. However, the COGS value is the same for both methods. The DOI value should be judged in its context as the value highly depends on the industry and its norms. The size of the business is also important for assessing the value. At times a high DOI is preferable depending on the market dynamics.
A company may decide to hold on to its inventory for a long time if it predicts an upsurge of demand in near future. The manufacturers of the products with seasonal demand may experience a high DOI during a period of a year. Efficient managing the inventory level is important for most of the businesses especially involved in producing merchandises. A large inventory may result in a huge loss for the company whereas a small inventory may signify a loss of sales in future due to the failure of meeting the market demand.
Academic Research on Days Inventory Outstanding
- An analysis of working capital management efficiency in telecommunication equipment industry, Ganesan, V. (2007). Rivier academic journal,3(2), 1-10. This study uses financial data from telecommunication equipment companies to analyse the relationship between working capital management and profitability. The study finds that inefficient working capital management negatively affects profitability, but does not significantly impact the profits of the examined companies.
- An analysis of working capital management results across industries, Filbeck, G., & Krueger, T. M. (2005). American Journal of Business,20(2), 11-20. Companies can save money by minimizing the amount of funds tied up in current assets. This is referred to as working capital management. This paper examines the working capital management of companies in different industries. The authors find significant differences in measures of working capital across different industries and across time.
- Corporate debt financing and earnings quality, Ghosh, A., & Moon, D. (2010). Journal of Business Finance & Accounting,37(56), 538-559. This study examines the relationship between debt financing and the quality of earnings. The findings show that low levels of debt can have a positive influence on earnings quality, and that high debt levels can have a negative impact on earnings quality.
- WORKING CAPITAL MANAGEMENT AND PROFITABILITY: A CASE OF ALBA COUNTY COMPANIES., Danuletiu, A. E. (2010). Annales Universitatis Apulensis-Series Oeconomica,12(1). This study examines the relationship between working capital management and profitability in 20 Alba County companies between 2004 and 2008. The study finds that increases in working capital are correlated with decreases in profitability.
- The relationship between working capital management and profitability: Evidence from the United States, Gill, A., Biger, N., & Mathur, N. (2010). Business and economics journal,10(1), 1-9. This study examines the relationship between the cash conversion cycle and profitability among 88 companies from 2005 to 2007. The study finds that good working capital management leads to greater profitability.
- Effects of working capital management on SME profitability, Juan Garca-Teruel, P., & Martinez-Solano, P. (2007). International Journal of managerial finance,3(2), 164-177. This paper examines the effects of working capital management on the profitability of a sample of Spanish companies.
- Supply chain performance benchmarking study reveals keys to supply chain excellence, Stewart, G. (1995). Logistics Information Management,8(2), 38-44. This study presents a set of benchmarks that can describe and assess links in a supply chain. These measures provide insight into how to improve supply chain performance.
- The relationship of cash conversion cycle with firm size and profitability: an empirical investigation in Turkey, Uyar, A. (2009). International Research Journal of Finance and Economics,24(2), 186-193. The cash conversion cycle (CCC) is the amount of time it takes a company to convert its inventory and other costs into cash from sales. This study looks at the relationship between the length of the CCC and company size and profitability. After examining data from companies on the Istanbul Stock Exchange, the author finds that longer CCCs correlate with smaller, less profitable companies.
- Cash flow management and manufacturing firm financial performance: A longitudinal perspective, Kroes, J. R., & Manikas, A. S. (2014).International Journal of Production Economics,148, 37-50. This study examines the relationship between cash flow and financial performance of over 1,200 companies. It finds that by one measure (the Operating Cash Cycle) improvements in cash flow lead to lasting improvements in company value and financial performance.
- Measuring the value of the supply chain: linking financial performance and supply chain decisions, Camerinelli, E. (2016). Routledge. This book demonstrates how a supply chain contributes to a companys bottom line. The author offers a common language to facilitate supply chain communication between decision makers within a company, and explores various metrics of supply chain performance.