What it means
Inventory is cash that has been turned into products, so every extra day goods spend on a shelf is a day that money cannot be used elsewhere. DAIO converts inventory levels into days, which makes the figure easy to understand and compare.
Saying that a company holds 50 days of stock tells you more than quoting a pile of dollars. The measure uses average inventory rather than the closing balance.
Averaging the opening and closing figures smooths out seasonal swings and one-off purchases, and it gives a fairer picture of the stock the business typically carries. The denominator is cost of goods sold, because inventory is recorded at cost rather than at selling price.
DAIO is one part of the cash conversion cycle, which also includes days sales outstanding (how long customers take to pay) and days payable outstanding (how long the business takes to pay its suppliers). Adding DAIO to days sales outstanding and subtracting days payable outstanding shows how long cash is tied up in operations.
Shorter is generally better, because it lowers the amount of funding the business needs. What counts as a good DAIO depends heavily on the industry.
A grocery chain with perishable products may hold a few days of stock, while a jeweller or a machinery maker may reasonably hold several months. The useful comparison is against the same business over time and against close competitors, not against a different sector.
The nuance is that lower is not always better. Very low DAIO can mean stock-outs and lost sales, and a high figure may be deliberate, such as stockpiling before a price rise or a busy season.
Obsolete or slow-moving items can also hide inside the average, so many teams review DAIO by product line.
In practice
Real-world examples.
Example
A hardware wholesaler cuts its DAIO from 70 days to 55 days by removing slow-selling lines and ordering more often in smaller quantities. With daily cost of goods sold of $10,000, it releases 15 x 10,000 = $150,000 of cash. The money is used to repay part of an overdraft.
Example
A fashion retailer reviews DAIO after a season in which it overbought winter coats. The figure jumps to 120 days at the end of March, so the buyer plans clearance sales and reduces orders for next year. The finance director warns the board that unsold stock may need to be written down.
Example
A food manufacturer compares its DAIO of 18 days with a competitor's 12 days. The operations team finds the gap comes from holding extra packaging materials as a safeguard against supplier delays. After negotiating more reliable deliveries, the company cuts the buffer by a few days.
Formula
Calculation
DAIO = (average inventory / cost of goods sold) x 365, where average inventory = (opening inventory + closing inventory) / 2
Suppose a distributor has opening inventory of $380,000, closing inventory of $420,000 and annual cost of goods sold of $2,920,000. Average inventory = (380,000 + 420,000) / 2 = $400,000. DAIO = (400,000 / 2,920,000) x 365 = 50 days. The same answer comes from cost of goods sold per day: 2,920,000 / 365 = $8,000, and 400,000 / 8,000 = 50 days.Case study
Seen in the real world.
Ridgeway Appliances is an illustrative, fictional retailer of kitchen appliances with five stores and an online shop. Its lender asked why borrowing had increased even though sales were flat, and the finance manager traced the problem to inventory.
DAIO had crept up from 62 days to 88 days over two years, as each store manager ordered extra stock to avoid missing sales. With cost of goods sold of $9,125,000 a year, or $25,000 a day, the extra 26 days meant about $650,000 of additional cash tied up in stock.
The company introduced a central buying team, a weekly review of slow-moving items and a target of 70 days. In this illustrative story, DAIO fell to 71 days within a year and the overdraft was cleared.
Watch out
Common mistakes.
- Using closing inventory instead of the average, which can distort the result if stock was built up or run down at the end of the year.
- Dividing by sales instead of cost of goods sold, which mixes stock at cost with revenue at selling price and understates the days.
- Comparing DAIO between different industries, when typical stock levels vary enormously.
Questions
People also ask.
Is DAIO the same as days inventory outstanding?
Yes, they are different names for the same measure, and some sources also call it days sales of inventory.
What is a good DAIO?
There is no universal answer, because it depends on the industry, product shelf life and supply chain, so compare against your own history and direct competitors.
How can a business lower its DAIO?
It can improve forecasting, order in smaller batches, clear slow-moving lines, negotiate faster supplier deliveries and agree consignment arrangements, while watching service levels.
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