Days inventory outstanding measures the average number of days required for a business to sell its inventory. It is calculated as follows:
= Days inventory outstanding
For example, a business maintains an average inventory of $300,000. Its annual cost of goods sold is $2,000,000. Based on this information, its days inventory outstanding is calculated as follows:
($300,000 Average inventory / $2,000,000 Cost of goods sold) x 365 Days
= 54.75 Days inventory outstanding
A low days of inventory figure is generally considered to represent an efficient use of the inventory asset, since it is being converted into cash within a reasonably short time. In addition, a short holding period allows little chance for inventory to become obsolete, thereby avoiding the risk of having to write off some portion of the inventory asset. A business can improve its days of inventory metric by using a just-in-time production system, as well as by accepting more inventory stockouts and promptly dispositioning any inventory that it does not expect to sell.
Some businesses take an alternative view of the measurement, preferring to accept a longer days of inventory figure in order to carve out a service niche. For example, a business may choose to maintain high inventory levels in order to advertise that it can fill any customer order within 24 hours of order receipt. In exchange for maintaining a large inventory investment, the company charges a high price for its goods. As another example, a company positions itself to be a purveyor of spare parts, which requires it to maintain a significant inventory of spare parts that it may not sell for years. Thus, the days inventory outstanding figure can be misleading, depending on how a business chooses to use its inventory.