What is Days Inventory outstanding?
Days Inventory outstanding or Inventory Days is yet another important activity ratio.
Earlier, we discussed Inventory turnover ratio which indicates the number of times the company turns its inventory during the year.
Now, let us look at – Days Inventory outstanding.
This ratio is also known as Inventory turnover days, Days sales in inventory, etc.
Days Inventory outstanding meaning
Days Inventory outstanding basically indicates the number of days the company takes to sell its inventory.
It also indicates the number of days money is blocked in inventories. This represents the opportunity cost of funds.
Hence, it is not preferred to have very high Days inventory on hand. We will explain the interpretation and reason shortly.
Inventory Days formula
The formula for Days inventory outstanding is closely related to the Inventory turnover ratio.
We take the Average Inventory in the numerator and Cost of Goods Sold (COGS) in the denominator and then multiply it by 365.
Average inventory can be obtained from the Balance Sheet and COGS can be obtained from the Income Statement.
On paying close attention, we can see that this formula is inversely related to the inventory turnover ratio formula.
Here is a quick recap of the Inventory turnover ratio formula.
Now, look at the Inventory days formula.
Below aspects need to be considered while calculating the numerator and denominator.
Cost of Goods Sold / Cost of sales
- COGS refers to the costs that are incurred directly as part of the production process.
- Examples of COGS are Raw material cost, labor cost, and other direct expenses.
- Indirect expenses like Interest expense, Taxes, etc should not be part of COGS
Average Inventory
- Average inventory can be obtained from the Balance Sheet.
- We need to take an average of closing inventory as at current period-end and previous period-end.
To understand the formula better, let us consider few examples.
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Inventory Days Example
Let us look at our 1st example.
Let us consider Company A and Company B as part of this discussion.
Values given in the examples below are in $ millions.
Consider the below-given income statement for both the companies.
To calculate Days of Inventory Outstanding (DOH), we need
- Average Inventory
- Cost of Goods Sold
But first, let us calculate COGS for both the companies.
Company A
- Raw Material = $100
- Labour wages = $350
- Direct expenses $50
- COGS = $ 500
Company B
- Raw Material = $200
- Labour wages = $400
- Direct expenses $200
- COGS = $ 800
Now, to calculate Average Inventory for both the companies, consider the below-given Balance Sheet.
Let us calculate Average Inventory for both the companies.
In the given example, only one period data has been given.
Hence closing Inventory balance can only be considered as average inventory.
Average Inventory
- Company A = $ 123
- Company B = $ 123
Now that we know all the values, let us calculate Days Inventory outstanding for both the companies.
Days Inventory on hand = (Average Inventories / COGS ) *365
- Company A = ($123/$500) *365 = 89.79 days
- Company B = ($123/$800) *365 = 56.11 days
What this means is that Company A takes around 89 days to sell all of its Inventory during a year.
This indicates that Company A’s funds were blocked in inventories for almost 89 days.
Such money blocked in the inventory for a prolonged period is considered as an opportunity cost.
On the contrary, Company B is able to clear the stock in almost 56 days which relatively lower than that of Company A.
Hence it manages its inventory in the most efficient manner. This also helps in the quick release of funds blocked in inventory.
DOH on a standalone basis, will not give a clear idea.
Hence, it has to be compared with industry standards to make better economic decisions.
Inventory Days using excel
In our next example, let us calculate Days Inventory outstanding using excel.
You can download the Days Inventory outstanding template for Walmart using the below option.
Below shown is the Consolidated Income Statement of Walmart.
Cost of goods sold
In the case of Walmart, COGS can be easily calculated from the income statement.
COGS = $ 385,301
To calculate Average Inventory, consider below-given consolidated Balance Sheet for Walmart
Also, we have an extract of Total Assets from Balance Sheet of Walmart Inc.
Average Inventory
- Closing Inventory 2018 = $43,783
- Closing Inventory 2019 = $44,269
- Average Inventory = ($43,783 + $44,269) / 2
- Average Inventory = $44,026
Now that we know all the values, let us calculate Days Inventory outstanding for Walmart.
As clearly evident, Walmart has moderate Days Inventory outstanding of almost 42 days.
What this means is that Walmart will take on an average 42 days to clear all the inventory for a year.
Funds are blocked in Inventories for 42 days in the case of Walmart.
If you recall, Walmart Inventory turnover ratio was 8.8 times.
Now, corresponding Days Inventory outstanding for Walmart is 42 days.
Since both the ratios are inversely related, we can arrive at the below interpretation.
Higher the Inventory turnover ratio > Lower will be the Inventory Days
Lower the Inventory turnover ratio > Higher will be the Inventory Days
Days Inventory outstanding interpretation
- Generally, a high Days inventory outstanding indicates that the company is unable to clear its stock from the warehouse timely.
- It indicates trouble either in demand for the products or marketing team’s inability to sell more goods.
- Also, rising DOH ratio leads to piling up of stock.
- Such a situation further leads to a low liquidity position as the funds are blocked on these inventories which are taking a long time to clear.
- On the other hand, a low Days inventory outstanding indicates that the company is more efficient in managing its inventory as it is able to sell its inventory more frequently.
- This helps in better inventory management. This helps in enhanced liquidity position since funds are blocked in inventory for a very short period.
Trend Analysis
To understand any financial ratios in-depth, standalone analysis will lead analysts nowhere.
Hence, a particular ratio has to be analyzed for historical periods. Hence, the Trend Analysis has to be performed.
Trend Analysis refers to analyzing any financial metric for historic periods with an intent to gain a deeper understanding about the said metric. It indicates any fluctuation or stability in the performance so that better economic decisions can be taken.
Let us look at how Days Inventory outstanding has moved historically in case of ExxonMobil
ExxonMobil is a US-based multinational oil and gas company. As part of its business model, the company has a huge inventory of oil reserves.
Managing such inventory balance is not an easy task.
As evident, DOH in the case of ExxonMobil is quite volatile.
It jumped from 19 days to 42 days between 2015-17, but gradually the ratio came down to 34 days.
Similar trend analysis has to be performed for other companies to observe any unusual behavior.
Comparison with similar companies
It is also important to compare DOH of the company with other similar companies in the same industry.
This helps in understanding how is the company performing when compared to other competitors or industry as a whole.
Walmart vs Amazon
Days Inventory outstanding for companies in the retail sector will be typically high since they have to deal with a huge pile of inventory on a daily basis. This is an integral part of their business model.
In the case of Walmart (which runs a chain of hypermarkets, discount department stores,
and grocery stores), you can see that Days Inventory outstanding is around 42 days.
Similarly, Amazon also needs to maintain a very high inventory as part of its business model. Hence Amazon Inventory days is 44 days.
It is interesting to note that both Walmart and Amazon are not able to decrease their DOH.
Nonetheless, they are able to maintain a steady-state DOH in the range of 40-45 days. Stability in any financial ratio is also viewed positively
Home Depot
In the case of Home Depot – a home improvement retailer ( supplies tools, construction products, and various similar services), you can observe that the ratio is relatively high.
Such a high DOH hinders the company’s liquidity position since most of the funds are blocked in inventories.
Hence, the company must try to reduce the ratio by implementing better supply chain management or any other inventory management techniques.
Currently, the Home Depot inventory days is 69 days.
ExxonMobil
As already discussed as part of Trend Analysis, Exxon Mobil is a US-based multinational oil and gas company. Generally, oil and gas companies are asset-heavy companies.
As part of their business model, they ideally maintain reserves of crude and similar other resources.
DOH in the case of ExxonMobil is quite volatile.
It jumped from 19 days to 42 days between 2015-17, but gradually the ratio came down to 34 days.
Facebook vs Google vs Microsoft
Although not part of the chart above, tech-based companies like Apple, Facebook, Google(Alphabet) do not have inventories as part of their operations.
Hence, funds are not blocked in inventories.
This helps in increasing its overall liquidity position.
Important considerations
Below are few important aspects one must consider while analyzing any company using Days Inventory outstanding. These are similar to what we saw as part of the Inventory turnover ratio resource.
Manufacturing companies
DOH is more relevant and useful for manufacturing companies rather than service-based companies.
This is because manufacturing companies are more inventory dependent than service-based companies.
Multiple Business verticals
If a company is in both manufacturing and service-based business, the ratio should be calculated by taking the segmental COGS and segmental Average Inventory.
Taking overall COGS and inventory balance will not give an accurate picture.
Next reading
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