# Days Inventory Outstanding

Days inventory outstanding (DIO), defined also as days sales of inventory, indicates how many days on average a company turns its inventory into sales. Value of DIO varies from industry and company. In general, a lower DIO is better. A useful tool in managing and improving inventory turns is a Flash Report!

## Days Inventory Outstanding Explanation

Days inventory outstanding ratio, explained as an indicator of inventory turns, is an important financial ratio for any company with inventory. It shows how quickly management can turn inventories into cash. In general, a decrease in DIO is an improvement to working capital, and an increase is deterioration.

## Days Inventory Outstanding Formula

Calculate the days inventory outstanding formula using the following equation:

DIO = (average inventory / cost of goods sold) * 365 days

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## Days Inventory Outstanding Calculation

Days inventory outstanding calculations cross a myriad of needs and purposes.

For example, a business has \$2,500 in inventory on average, \$25,000 in cost of goods sold.

DIO = (2,500 / 25,000) * 365 = 37 days

## Days Inventory Outstanding Example

For example, James is the owner of a grocery store. His store, a private seller of groceries to a large suburb, has grown to be a household name in his local area. James now wants to find his DIO for his store, as well as, select product lines.

James begins by talking to his accountant. The accountant, skilled in his profession, performs this days inventory outstanding analysis:

James’ store has \$2,500 in inventory on average, \$25,000 in cost of goods sold.

Days Inventory outstanding = (2,500 / 25,000) * 365 = 37 days

James’ store is keeping pace with the national market of grocery stores. In his state, however, James’ store could use a little improvement. James considers options such as clearance item discounts or running coupons on items which he wants to sell faster. These promotions, including lower prices, could produce the inventory turnover which James is looking for.

James now looks to his bookkeeper for up-to-date information on his days inventory outstanding for certain product lines. James allows time to find these measurements and is confident that with the right team, perspective, and motivations he can grow his store further.

Reducing days inventory outstanding is just one of the many ways to improve the cash flow of a company. If you’re looking for 24 ways to improve cash flow, download the free 25 Ways to Improve Cash Flow whitepaper.

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## Resources

For statistical information about industry financial ratios, please go to the following websites: www.bizstats.com and www.valueline.com.

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# Cost of Goods Sold (COGS) Definition

Cost of Goods Sold (COGS), defined as the inventory expense that is sold to customers and is known as the largest expense to a company. It is also referred to as the Cost of Sales, and the two are used interchangeably.

## Cost of Goods Sold Explained

Cost of Goods Sold, explained as being an expense, has a direct correlation with the inventory which is considered an asset. Derive the COGS equation from the inventory which will be shown later. In addition, the Cost of Sales falls right underneath the Revenue or Sales on the Income Statement. In fact, the Gross Margin is the result of Revenue minus the COGS. Also, divide the Cost of Goods Sold by Sales to find Gross Profit Margin percentage. The Gross Profit Margin percentage gives a company insight into what they need to charge for a certain product. Or they may find a component of the Cost of Goods Sold expense to reduce.

### Cost of Goods Sold Formula

The formula or Cost of Goods sold equation is as follows:

Cost of Goods Sold Beginning Inventory
+ Net Purchase (raw materials, labor, and overhead)
= Cost of Goods available for sale
–  Cost of Goods Sold ending inventory
= COGS

### Example

Printer Inc. sells printers and other computer components to the the general public. Peggy an accountant is in charge of the inventory and Cost of Sales as it posts to the income statement. She finds the following numbers:

Beginning Inventory = \$20,000
Manufacturing or Purchase Costs = \$120,000
Ending Inventory = \$30,000

Then calculate the Cost of Goods Sold as follows using the formula above:

\$20,000 + \$120,000 = \$140,000 or the Cost of Goods available for sale

\$140,000 – \$30,000 = \$110,000 or the Cost of Goods Sold

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# COGS and the Balance Sheets for a Service Based Business

If you are running a business with inventory, it’s easy to understand the G in COGS (Cost of Goods Sold). But if your Goods are employee time, how do you note your goods in the P&Ls? How do you list the time on your balance sheet? The answers to this questions depends upon what you are trying to do with your P&Ls and what you are trying to do with your balance sheet.

## P&Ls

Here is a school of thought regarding P&Ls.

Place all your service oriented employees salaries in COGS. What this does in a sense is place a debited amount against the income that you have coming in so when you look at the Gross Profit, you can tell your profit just based on the services that you are performing for your customers. You can now use this as a guide for hiring new employees that directly influence income. Through your gross profit, you will be able to tell whether or not you have enough GP to pay for more resources just as you would to determine if you have enough to buy certain quantities of inventory.

The important thing to note is that you have to be acutely aware of what your Expense ratio is. What that means is that if you add employees and it affects your GP, you will need to leave enough GP to pay Expenses so your net number is positive.

All of this said, if your goal is to have a high GP so that it looks good on your P&Ls, don’t do this! Leave all your service salaries in Expenses. This is just a different way to do tracking of Cost of Resources on your P&Ls. This can all be done outside of accounting in some type of operational cost reporting.

### Categories of Assets

With the Balance Sheet, the problem often becomes, “how do I value an employee time on my balance sheet as an asset.” The answer is, “you can’t”. The categories of assets as understood by GAAP are:

1. Cash

2. Short Term Investments

5. Prepaid Expenses

Inventory comes close to being able to placing resource time on the books. But once again, “you can’t”. Coming close does not count in accounting. Accurately adhering to GAAP is vital.

So that you can increase your company’s worth on the balance sheet, there are a couple ways that you can place the money that the resources will make on the Balance Sheet:

1. Long Term Contracted Revenue – Asset/Receivables from income invoices generated for the life of the contract.

2. Equity/Goodwill

The first one (Receivables) is an easily understood principle. The second (Good Will) is much more difficult.

All of the practices noted are ones that you should deeply consult with a seasoned and professional CPA and Valuator before you try and tackle on your own. Generate ideas using this article, and do not use it as accounting advise.

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# Cash Cycle Definition

The cash cycle definition is the time it takes a company to turn raw materials into cash. It is also a common concept in any business which processes materials. Also known as the cash conversion cycle, it refers to the time between purchasing the raw materials used to make a product and collecting the money from selling the product. It also functions well as a measure of liquidity: how easily can unfinished product be turned into cash.

Find out if reducing your cash conversion cycle is worth the effort!

## Cash Cycle Explanation

Cash cycles are typically measured in days. A shorter cash cycle is better than a longer cash cycle. A company with a shorter cash cycle has more working capital and less cash tied up in inventory and receivable accounts, which means it is less dependent on borrowed money. Cash cycle depends largely on operational efficiency. Factors that effect the cash cycle include labor efficiency, the quality of raw materials, quality of equipment, efficiency of management structures for processing materials, economic and market influencers, and more.

## Cash Cycle Formula

Simply, the cash cycle calculation can be performed with:

Inventory to product conversion time + receivables collection time – Payables payment time

When measured in years the cash cycle equation is:

Average inventory / (cost of goods sold / 365) + Average AR / (Sales / 365) + Average AP / (COGS / 365)

## Cash Cycle Example

For example, Ronald owns a custom gun smithing service. As a sole proprietor, Ronald has never paid much attention to creating financial statements as long he could pay his bills. Due to the recent change in national administration and economic state, he has had to change this view to accommodate increased demand for his services. Ronald is curious how long it takes him to convert materials to income. With this he will attempt to increase efficiency as well as production capacity. Studying his cash conversion cycle provides insight into his work processes as well as the liquidity of his business operations.

Ronald will begin by completing the process in a simple way. He begins keeping a pad close while he works to monitor how long it takes him to make a product.

Then, Ron looks in his quick books to find out the average amount of time it takes him to be paid. He has never been much of a collections agent but is still a little disturbed by how long it takes customers to pay. Ron puts his heart and soul into his work and feels he deserves better.

Finally, Ronald looks back to see how long it takes him to pay his suppliers. Ron has never pushed for credit terms and realizes that he has always paid vendors upfront.

Ron finds a cash cycle template online to simplify his calculation. Ron’s eyes are opened from this experience. His method of doing business as a sole proprietor was satisfactory but Ron will have to make some changes to accept the success that he can freely receive. He knows he is ready for the change but considers hiring a business consultant to make sure he does the job right the first time. He takes a moment to think about the future and smiles; Ronald is ready for the challenge that awaits him.

For more ways to improve your cash cycle, download your free A/R Checklist to see how simple changes in your A/R process can free up a significant amount of cash.

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# Accounting Changes

Accounting changes and error corrections are the switch from one principle of accounting to another – like with inventory and recognition of revenue. Error corrections come from an accounting change in estimates, such as accounting changes in depreciation method for assets or how it might record the company uncollectible accounts. For example, a company might decide that it needs to switch to straight line depreciation from an accelerated method. This makes it easier and in line for tax purposes. Companies might also decide that a better way of accounting for its inventory is to adopt the Last in First out (LIFO) method; instead of a First in First out (FIFO) method.

## Disclosure of Accounting Changes

Regardless of the accounting change, when a company adopts a new method of accounting, GAAP requires companies to disclose these changes in the financial statements. Whenever the company is writing its notes to inform the (potential) investor, it must announce the specific change first. Then it is required to announce the impact that this change will have upon the company’s income and the balance sheet.

## Accounting Changes Example

Jimbo Slice works for a toy manufacturer by the name of Awesome Toy Co. The economy has recently gone through a downturn and the company expects that it will not receive a larger amount of its accounts receivable because many of its customers are on the verge of declaring bankruptcy. Jimbo has decided that a change in accounting estimate is needed in regards to the estimation of bad debt expense. At the year end, Jimbo must list this change in estimate on the financial statement and its effect on income which is most likely a reduction.

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# Accounting Asset Definition

In accounting, an asset has two criteria: a company must own or control it, and it must be expected to generate future benefit for that company.

## Assets on Balance Sheet

A company records the value of its assets on the balance sheet. Assets can be classified as current assets or as non-current assets.

Expect to use up or convert current assets, such as accounts receivable and inventory, to cash within one year or one operating cycle.

Non-current assets, also called fixed assets, such as plants and equipment, have useful lives longer than one year or one operating cycle.

### Tangible – Intangible

Categorize assets as tangible or intangible. Report both types on the balance sheet.

Tangible assets are physical assets, such as land, machinery, and inventory. Depreciate the value of these assets over their useful lives.

Intangible assets are nonphysical assets, such as brand name, intellectual property, and goodwill. Certain intangible assets, such as goodwill, are amortized over their lifespan. Intangible assets can be either definite or indefinite. Definite intangible assets have a limited lifespan. Indefinite intangible assets exist as long as the company that owns them is a going concern.

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## Incentive Comp Plans Driven by Business Model

The traditional thought process is to decide how your business will make money and then develop incentive comp plans to encourage employees to act in a way that supports the business model.  But that is not always the way things work in real life. Sometimes an incentive compensation plan that sounds great on paper ends up driving a very different set of behaviors than anticipated.

One business I worked with set up an incentive system to encourage profitable sales growth. Even the president was rewarded when the company grew sales and made more money. At least that is what the income statement said. However, the owners were not able to take more money out of the business. In fact they had to keep borrowing to support the increase in inventory that the company kept buying. Eventually the inventory was literally worth more than the whole business. The owners owed money to the bank and they could not take any more money out of the company. All because of an incentive system that was not what it first seemed to be.

A slight change in the incentive system to include the cost of inventory immediately changed behaviors at the company, brought the bank line down to zero, allowed the owners to take more money out of the company – and in the end – profits increased!