DIO is a financial metric that measures the average number of days it takes for a company to sell its inventory. This metric is used to evaluate how efficiently a company manages its inventory and how quickly it turns over its inventory into cash.
DIO is important, because it helps companies understand how long it takes for them to sell their inventory and how quickly they can generate cash from their sales. A high DIO indicates that a company is holding on to its inventory for a long time, which ties up cash that could be used for other business activities. On the other hand, a low DIO indicates that a company is selling its inventory quickly, which means it can generate cash faster and reinvest it into the business.
DIO is calculated by dividing the average inventory by the cost of goods sold (COGS) and then multiplying that number by the number of days in that period. The formula for DIO is:
DIO = (Average Inventory / COGS) x Number of Days
To calculate the average inventory, take the sum of the beginning and ending inventory levels for a period, like a quarter or a year, and divide it by two. The number of days used in the formula is typically 365, but it can be adjusted to reflect the length of the period being analyzed.
For example, a company has an average inventory of $100,000 and its COGS is $500,000 for a year. Using the formula from above we can calculate the DIO as:
DIO = ($100,000 / $500,000) x 365 = 73 days
This means that, on average, it takes the company 73 days to turn over its inventory into cash. A high DIO of 73 days indicates that the company is holding on to its inventory for a longer period, tying up cash that could be used for other business activities. The company may need to analyze its inventory management process and consider ways to reduce inventory levels or increase sales to improve its DIO and cash flow generation.