Inventory Turnover: What is the Difference? One caveat is that companies with a low DIO might be overwhelmed if demand were to see a sudden increase if inventory were to ever fall to zero, then the company would be missing out on potential salesĭIO vs.Or in the worst-case scenario, the product may have become obsolete and substantial discounts would be required to get rid of the inventory (or incur an inventory write-down).If a company has a low DIO, that means it is converting inventory into revenue more quickly – meaning more FCFs are available for reinvestments or other purposes like paying down debt.The company may be failing to convert inventory into sales or is not managing inventory efficiently compared to others due to an ineffective marketing strategy where it fails to get enough exposure compared to others in its sector.As a general rule of thumb, lower DIO is viewed more favorably since it implies the company is more efficient at selling its inventory (and is avoiding stock-piling inventory).If the number of days it takes on average to clear out the inventory is high relative to comparable peers, there may not be enough demand for the product, the pricing might be too expensive, or it may be time to reconsider the target customer profile, etc.That is why the inventory turnover ratio and days inventory outstanding (DIO) are valuable metrics to track for companies, especially those selling physical products (e.g., retail, e-commerce). In addition to being an indicator of ordering and inventory management efficiency, a high inventory turnover ratio and low DIO means higher free cash flows. ![]() The average inventory turnover and DIO varies by industry however, a higher inventory turnover and lower DIO is typically preferred as it implies the management of inventory is closer to an optimal state. The formula to calculate days inventory outstanding (DIO) consists of dividing the average (or ending) inventory balance by cost of goods sold (COGS) and multiplying by 365 days.ĭays Inventory Outstanding (DIO) = 365 Days ÷ Inventory Turnover What is a Good Days Inventory Outstanding?Ī comparative benchmarking analysis of a company’s inventory turnover and DIO relative to its industry peers provides useful insights into how well inventory is being managed. With that said, if the inventory balance of a company rises, that means more cash is tied up in the operations, since it is taking more time for the company to sell and cycle through its inventory compared to the time needed to produce it. current operating assets minus current operating liabilities – causes a reduction in the free cash flow (FCF) of a company. Hence, an increase in working capital – i.e. Cost of Goods Sold (COGS) → On the income statement, the COGS line item represents the direct costs incurred by a company while selling its goods or services to generate revenue.Īn increase in an operating working capital asset, such as inventory, represents an “outflow” of cash.Inventory Balance → On the balance sheet, the inventory line item represents the dollar value of the raw materials, work-in-progress goods (WIP), and finished goods of a company. ![]() ![]() To calculate the days inventory outstanding (DIO) of a company, two inputs are necessary: Therefore, companies are incentivized to minimize their days inventory outstanding (DIO) to reduce the time that inventory is sitting idly in their possession, since that implies its operating efficiency improved. ![]() How to Calculate Days Inventory Outstanding?ĭIO stands for “Days Inventory Outstanding”, and measures the number of days required for a company to sell off the amount of inventory it has on hand.
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