Days Inventory Outstanding Explained
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.
A Little More about Days Inventory Outstanding
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.
References for Days Inventory Outstanding