The average time for which a company holds its inventory before selling it is determined by “days in inventory”. Other names prevalent in some organizations are days inventory outstanding, inventory days outstanding or inventory days of supply. Once days in inventory are determined, a company can more accurately determine its efficiency in terms of finances and operations. It also helps to tell how quickly a company can sell its inventory.
If the inventory figure is small then it implies that the company is quickly selling its goods. There may be a situation in which a company discovers that its conversion via sales is slow. This can show which products may be moving slowly.
What is the Definition of Days in Inventory?
Days in inventory is an inventory management metric that shows the average number of days it takes a company to turn its inventory into sales. The inventory that’s considered in days in inventory calculations is work in process inventory and finished goods inventory.
It’s a company’s average days to sell inventory, basically. The lower the number, the better. That’s less days inventory is held. That means lower inventory carrying cost and less cash is tied up in inventory for less time. And there’s less risk that inventory expires or becomes obsolete.
Calculating days in inventory is crucial for any business in order for it to be successful. It is one of the many inventory management techniques that business owners should understand.
The Formula for Days in Inventory
In order to calculate the days in inventory you just have to divide the average inventory by the COGS (cost of goods sold) in a day. The average inventory is calculated by coming up with the average between the inventory levels at the beginning of an accounting period and the inventory levels at the end of the said accounting period. Note that results from this method are sensitive to how you calculate average inventory. The most common way is to add beginning inventory and ending inventory, then divide by two, for the time period in question.
Then, the COGS (cost of goods sold) can be calculated by dividing the total cost of goods sold in a single year by 365 days. On the other hand, the average days to sell the inventory metric is calculated by dividing 365 (the number of days) by the inventory turnover ratio.
Why Ecommerce Businesses Should Care About Days in Inventory
Businesses should care about days in inventory (sometimes abbreviated DII) for three main reasons.
1. Days in Inventory is Important for Inventory Management
A business can use the backward-looking formula to see how it did in the last quarter or year, but applying the same logic to sales projections and current inventory levels — especially when tracked precisely in an enterprise resource planning (ERP) system — offers a window into where the business is heading as well.
2. Days in Inventory is an Important Component of Cash Management
Too much cash tied up in inventory can cause problems elsewhere, such as the inability to pay a supplier on time or invest in a new opportunity because all your money is tied up in inventory. For many businesses, storing inventory may be costly, too. Monitoring DII can help prevent those kinds of issues from happening.
3. Days in Inventory is a Measure of Efficiency
A single number for a single time period may not mean much in isolation, but when DII is tracked over time, it may uncover changes and trends that, in turn, could provide signals about inventory management. For example, a slow and steady decline in DII may be a sign that a new sales strategy is working, while a sudden jump may indicate an inventory problem. (Remember not to diagnose a red flag solely on DII.) DII can also be used to compare similar companies in the same industry during the same time period.
DII calculations matter more for companies that deal primarily or exclusively in physical goods, and especially so for those that sell perishable inventory. Days in inventory drifting too high for products that go bad and become worthless could result in huge monetary losses, as opposed to more standard inventory, where upward DII means the business will likely incur slightly too high carrying costs and slightly too low liquidity.
What Does a High or Low Days Inventory Mean?
A high days in inventory number specifies that a company is incapable of rapidly transforming its stock into sales. Its reasons can be the acquisition of a lot of inventory or poor sales performance.
A low days in inventory figure specifies that a company can more rapidly transform its inventory into sales. Hence, a low DII indicates a more efficient sales performance and proper inventory management.
Too low inventory is disadvantageous to a company because the stock might turn obsolete and inferior. On the other hand, holding surplus inventory negatively influences the company’s capital.
Other Names for Days in Inventory
There are many ways to refer to days in inventory. They all have their own acronyms, which may make you think they’re different from DII in some way. While they aren’t necessarily different, they can sometimes be used in different contexts.
Days Sales In Inventory: (DSI)
You will see days sales in inventory, or DSI frequently. Days sales in inventory is a measure of the average time in days that it takes a business to turn inventory into sales. Referring to this metric as DSI specifically is often done when companies want to emphasize how many days the current stock of inventory will last.
Inventory Days On Hand: (DOH)
DOH stands for inventory days on hand. It’s interchangeable with DII, DSI, and DIO. DOH measures the number of days inventory remains in stock—or on hand.
Days Inventory Outstanding: (DIO)
Days inventory outstanding, or DIO, is another term you’ll come across. It’s the same exact financial ratio as days in inventory or DSI, and it measures average inventory turn-in days. DIO is often used interchangeably with DSI.
Inventory Turnover Days
Inventory turnover days is yet another way to refer to the average days it takes companies to turn their inventory into sales. But what’s the difference between inventory turnover days and inventory turnover?
Inventory turnover ratio shows how quickly a company receives and sells its inventory. Sell through rate is similar. The higher the number, the better. Inventory turnover days, on the other hand, calculates the average number of days a company takes to sell its inventory. The lower the number, the better. They are related, yet the inverse of each other.
There are risks associated with decreasing your days in inventory on hand, so it’s important to determine your business’s particular risk tolerance. Not carrying enough inventory can lead to stockouts, lost sales, and ultimately lost customers. If a shopper lands on your site for the first time and is greeted with an out of stock notification, they will likely find what they’re looking for somewhere else.
To avoid issues like these it is important to monitor inventory levels and turn off marketing campaigns and promotions when inventory is low. Ultimately you have to weigh the risk of missed sales opportunities against the increased profit potential to make the best decision for your business.
Help with inventory management is one of the many benefits to working with a 3PL. If you are seeking logistics support we’d love to hear from you. You can read DCL’s list of services to learn more, or check out the many companies we work with to ensure great logistics support. Send us a note to connect about how we can help your company grow.
Tags: Calculators & Formulas