How do you determine a retailer’s success? What are the retailer’s KPIs? One of the most important metrics alongside with customer traffic, average sale and conversion rate, is the days inventory outstanding, or the ability and speed of turning inventory into sales.
Days inventory outstanding (abbreviated as “DIO”) is the average number of days needed to sell the inventory which stays on warehouse or store shelves before being sold to customers. In other words, DIO is a financial performance indicator showing company’s ability to quickly sell its goods.
Let’s examine this important indicator.
Days inventory outstanding is calculated in days and shows a time period which is required to sell the products. The lower this indicator is the better retailer performs, and the faster his inventory is converted into money. On the opposite, if DIO indicator is high, it points to either inefficient sales strategy or other inventory management problems.
The DIO indicator helps businesses to obtain a helicopter view on holding and storage costs and to identify the drawbacks and potential problems in sales and inventory management processes.
Days inventory outstanding is not a standard figure and it does not represent a unified indicator - instead, this metric varies depending on the retail industry and specifics.
To get DIO figure, you need to have the following indicators ready:
COGC (Cost of Goods Sold) - you may read here about this indicator and get the instructions on its calculation. Put very briefly, COGS is an actual money paid for total amount of goods (plus logistics costs) received from a supplier to warehouse within a time period. Usually the year is viewed as an accounting period;
Average inventory - to get this indicator you have to take your beginning and ending inventory balance (in money equivalent) for a month and divide by 2.
Here is the DIO formula:
DIO = (Average inventory / COGS) x 365 days
Let’s analyze the practical case and calculate the DIO indicator.
A retailer who owns a cell phone shop, sells 3 popular cell phone brands. One day he decides to review his performance and calculate his DIO metric, which shows which of the brands is selling better than the rest. So, for the the cost of goods sold for Cell Phone Brand 1 is 10 000$, for Cell Phone Brand 2 is 12 000$ and for Cell Phone Brand 3 is 11 000$. The Average Inventory metric is calculated by dividing a total of a beginning and ending inventory by 2. For Cell Brand 1 the Average Inventory is 2000$, for Cell Phone Brand 2 is 1000$ and for Cell Phone Brand 3 is 1500$. So, let’s find the number of days needed to sell each Cell phone Brand inventory:
1) Cell Phone Brand 1: DIO = (2000$ / 10 000$) x 365 = 72
2) Cell Phone Brand 2: DIO = (1000$ / 12 000$) x 365 = 30
3) Cell Phone Brand 3: DIO = (1500/11000) x 365 = 50
Evidently, we have a winner - the Cell Phone Brand 2 sells faster and better than the others. The “silver” medal goes to the third brand, while the first brand is not doing very well. Being simple and easy-to-calculate, the DIO indicator immediately shows a big picture of retailer’s performance and points out the necessity of sales strategy and inventory turnover improvement.
In a nutshell, the DIO metric is a very important tool to measure company’s performance and take timely measures to improve its inventory turnover, minimize the risk of storing excess goods and increase overall cash flow.
DIO tool is often used by investors who analyze and compare company’s doing business, and sometimes DIO is used to assess inventory and procurement managers performance.
And, of course, you should understand that DIO is not the only one technique that should be used. First of all, you should always compare your indicators to the average figures across your peer industry. Second, in our agile and complex world a retailer who is seeking growth has to implement a complex approach to his inventory management and deploy a set of effective solutions, offered by modern technological inventory management software.