How To Use Days Inventory Outstanding (DIO) for Better Stock Management

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In my earlier article on working capital management,we noted that days inventory outstanding forms one part of the component of the cash conversion cycle.

This article attempts to explore the further detailed use of DIO in stock management:

If we look at DIO,the formula is simply:
Closing Stock / Cost of Goods Sold or costs of sales X 30 days(month) or X 90 (quarterly)

For analysis purpose,using DIO formula,we can classify the closing stock into various categories namely fast moving,slow moving or non moving stock by pre-defining the range of days.

For example:
Say we have closing stock of $10m,we can use the DIO to re-arrange into:
Fast moving stock –$3m for days below 90 days
Slow moving stock –$3m for days from 91 days to 179 days
Non-moving stock –$4m for days above 180 days

We can then relate this high percentage of non-moving stock in the closing stock to management for emphasizing the importance of better stock management.
Illustrated as a table:

Using this DIO,we can align the status of closing stock at a certain period directly to the average monthly sales (in this case in terms of quantity and if multiply by unit cost price = cost of goods sold/cost of sales). Detailed figures extracted this way will assist management to relate the importance of proper stock management which simply and factually stipulated how long the existing closing stock will be consumed.

As a norm,stock management should be looked at from the following areas:

• Lead time of stocks purchased
• Minimum quantity of stock being purchased
• Quality of the stocks
• Momentum of the sales ( cost of good sold)

However,in reality,selling personnel will dispute your figures of using past average monthly 3 or 6 months sales figure,insisting to use the forward looking average monthly sales.

Very simply,this can be reinstated by using forecasted sales of the stocks as the figure in the column Z. However,the danger is that if we were to use forecasted figures,we need to ascertain that the figures are accurate other wise,the DIO will be distorted,allowing overstatement of forecasted sales and giving more excuses to bring in more stock.

The financial executive,to avoid the risk of being oversold by selling personnel during the stock management exercise/review should preferably:

• Use both past and present average monthly sales figure ( the months of sales depend on the company’s nature of business) for counter checking or as complementary check,
• Always be wary of the forecasted sales figure by reviewing the trend and getting positive confirmation and or justification that sales are really moving up not just by one month trend,

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