Gaining visibility into your company’s accounts receivable can be enormously beneficial, helping you to manage expectations around payment times and boost the efficiency of cash collection. That’s why it’s a good idea to have a handle on DSO, or days sales outstanding. Find out everything you need to know about the days sales outstanding formula, including the benefits, limitations, and applications of this useful metric. First question – what is DSO?
What is DSO?
DSO – which stands for days sales outstanding – is a measure of the average number of days that companies take to collect payment after a sale. It’s essentially the opposite of DPO (days payable outstanding). If your business has a high DSO, it indicates that you take longer to collect receivables. This may mean that you’re exposed to a high level of risk and bad debt. By contrast, a low DSO can be reflective of a proactive credit management team that stays on top of their invoices. In most cases, a DSO that’s below 45 days would be considered “low,” although this can vary from industry to industry.
What is the days sales outstanding formula?
In order to determine how long it takes to collect on your business’s receivables, you’ll need to use the following days sales outstanding formula:
DSO = (Accounts Receivables / Net Credit Sales) x Number of Days
Let’s look at an example to see how the days sales outstanding formula works in practice. Imagine that Company A made around $250,000 worth of credit sales in June, on top of $120,000 in accounts receivable. As there are 30 days in June, you can complete your DSO calculation like so:
DSO = ($120,000 / $250,000) x 30 = 14.4
With a DSO of just 14.4 days, Company A’s turnaround time for collecting accounts receivable is very short, indicating that the company’s collections process is streamlined and effective, although it may also mean that their credit policy is a little too tight.
Why is days sales outstanding important?
Cash flow is the lifeblood of any organisation, and as such, it’s a good idea to prioritise accounts receivable. Due to the time value of money principle, cash that you spend a significant amount of time trying to get back is money lost. Understanding days sales outstanding can give you an invaluable insight into the efficacy of your company’s accounts receivable, which can help you take a proactive approach to cash collection. For example, if you’ve got a particularly high DSO, you should take steps to review your collection policy and weed out bad payers.
How to use days sales outstanding
There are many different ways to utilise a DSO calculation. Firstly, it can be an effective benchmark for analysing your business’s cash flow, and in many cases, looking at DSO trends is much more telling than individual DSO values. If, for example, your days sales outstanding is on the rise, it could indicate that your customers are becoming less satisfied with your service, and therefore taking longer to pay their invoices.
By tracking your DSO over weeks, days, and years, you can determine whether there are any long-term patterns you need to worry about. If your DSO is volatile and constantly changing from month to month, that’s something to pay attention to. However, a seasonal dip in DSO may not be too much cause for concern, especially if it happens at the same time every year.
Drawbacks of DSO calculations
Despite all the applications of days sales outstanding, there are a couple of limitations that you should bear in mind. If you’re comparing different businesses using DSO, it’s important to remember that DSO is only really useful when you’re weighing up companies within the same industry that have similar business models and revenue figures. In addition, the days sales outstanding formula isn’t especially helpful for comparing businesses with different proportions of credit sales.
We can help
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