Days Sales Outstanding DSO: Meaning in Finance, Calculation, and Applications

dso definition

It is used to determine the effectiveness of a company’s credit and collection efforts in allowing credit to customers, as well as its ability to collect from them. When measured at the individual customer level, it can indicate when a customer is having cash flow troubles, since the customer will attempt to stretch out the amount of time before it pays invoices. The measurement can be used internally to monitor the approximate amount of cash invested in receivables.

Or the company might take advantage of an opportunity to forge a closer relationship with a typically reliable customer that hasn’t paid due to extenuating circumstances, by offering a special payment plan. This example illustrates why evaluating companies based solely on DSO could be misleading. Company B’s DSO may reflect its willingness to extend credit to customers to achieve a higher sales volume — which could be either a smart business move or a risky proposition, if these buyers are financially unstable. DSO may also prompt questions about Company B’s cash flow and collections process. George Michael International Limited reported a sales revenue for November 2016 amounting to $2.5 million, out of which $1.5 million are credit sales, and the remaining $1 million is cash sales. Given the vital importance of cash flow in running a business, it is in a company’s best interest to collect its outstanding accounts receivables as quickly as possible.

What Is Days Sales Outstanding (DSO): The Lifeline of Accounts Receivable

The DSO ratio can be calculated by dividing the total amount of accounts receivable a company has within a specific period of time by the total dollar value of its credit sales during the same timeframe. Following that, this figure should be multiplied by the number of days in the measured duration. To calculate Days Sales Outstanding, you’ll need figures such as your accounts receivable balance and total credit sales from your company’s balance sheet. When calculating DSO, cash sales are not taken into consideration–only credit sales.

What is DSO and DPO formula?

DSO = ($95 / $9,000) x 365 days = 3.9 days. DPO = $850 / ($3,000 / 365 days) = 103.4 days. CCC = 182.5 + 3.9 – 103.4 = 83 days.

DDO is calculated by dividing the outstanding deductions by the average deductions in a certain period. As the name suggests, CEI measures how effective the collections team and their procedures are. Acknowledged as one of the best metrics to consider along with DSO, you can interpret the order-to-cash teams’ performance.

It can help you manage your cash flow more effectively

This figure gives management insight on how efficient the company’s accounts receivable department is and how much cash the company can spend. This figure also lets investors know how much cash the company has access to in order to cover the company’s debts. The period of time used to measure DSO can be monthly, quarterly, or annually. If the result is a low DSO, it means that the business takes a few days to collect its receivables. On the other hand, a high DSO means it takes more days to collect receivables.

dso definition

It can also damage your relationships with suppliers as they may see you as a high-risk customer. This could lead to them charging you more for goods and services or even refusing to do business with you altogether. An effective way to use the days sales outstanding measurement is to track it on a trend line, month by month. Doing so shows any changes in the ability of the organization to collect from its customers. If a business is highly seasonal, a variation is to compare the measurement to the same metric for the same month in the preceding year; this provides a more reasonable basis for comparison. Your customers are the lifeline of your business, and to grow, you need to retain them.

A vital business metric

All in all, working on strategies to improve your financial health (and financial statements) is time better used than on tiresome calculations. Let us do the heavy lifting for you so you can focus on your company’s long-term success. For this method, you need both your receivable balance and your gross sales amount over a given time frame – usually a month – from your balance sheet. Once you have these two numbers for each month, you compare them to each other going back in time. To get a more accurate result that factors in your normal yearly ebbs-and-flows of business, you’d have to calculate your DSO for these different periods. Then, you’d compare them against each other to get a loose idea of your cash conversion cycle.

When looking at sectors globally, the sectors with the highest DSOs were machinery (92 days), construction (82 days) and electronics (77 days). Conversely, retail was the sector with the lowest DSO at 26 days, followed by agrifood (43 days) and transportation (47 days). The higher your DSO, the greater your dso definition working capital, and the lesser your free cash flow. While it is tempting to calculate your DSO on an excel spreadsheet, it is not the best way to do it. If you want to use the countback method (the most accurate), then it requires a few formulas and probably some switching between different tables.

If a company’s DSO is increasing, it’s a warning sign that something is wrong. Customer satisfaction might be declining, or the salespeople may be offering longer terms of payment to drive increased sales. Perhaps the company may be allowing customers with poor credit to make purchases on credit. In general, small businesses rely more heavily on steady cash flow than large, diversified companies. If customers have a history of paying severely late, it could be a sign that you should stop extending payment terms to them.

Is DSO same as receivable turnover?

The key difference between the two is that the receivables turnover ratio measures how many times a business's receivables are turned over in a given period of time, while DSO measures the average number of days it takes to collect on receivables.

By tracking DSO proactively, your AR team will have a reliable pulse on how the company is maintaining these priorities. Days sales outstanding can vary from month to month, and over the course of a year with a company’s seasonal business cycle. Of interest when analyzing the performance of a company is the trend in DSO. If DSO is getting longer, accounts receivable is increasing or average sales per day are decreasing.

Remember, the longer you take to collect payments may negatively impact your company’s cash flow. That’s why you may want to consider automating your accounts receivable process. Not only does automation improve the days to collect, but it may help you to avoid a high DSO. Daily sales outstanding (DSO) is an acknowledgement of the importance of cash in business. Due to this, it is in the company’s best interest to collect due payments as quickly as possible. The daily sales outstanding ratio steps further to provide the average amount of time sales stand uncollected as compared to total sales.

dso definition

Consider sending payment reminders early so there is a longer time period for customers to pay. Most customers will appreciate the discount and it could lead to higher customer retention. When the days sales outstanding figure is employed to compare businesses, keep in mind that the DSO figure can vary by type of business model, which renders these comparisons somewhat less useful. For example, a business that competes by offering loose credit to bring in customers that no one else wants will inevitably have a higher DSO figure than one that uses a tighter credit policy. Managers, investors and stakeholders rely on DSO to determine how effective a company is at collecting outstanding balances from customers.

For example, if your DSO is equal to 32, it means it takes you 32 days on average to collect payment from your customers after sales. When using DSO to compare the cash flows of a number of companies, you should compare companies within the same industry, with similar business models and revenue numbers. If you try to compare companies in different industries and of different sizes, the results you’ll get will be misleading because they often have very different DSO benchmarks and targets. Generally, when looking at a given company’s cash flow, it is helpful to track that company’s DSO over time to determine if its DSO is trending up or down or if there are patterns in the company’s cash flow history.

dso definition

As accountants, you are likely experts in credit control and the management of accounts receivable. DSO is an important metric for businesses to track as it can have a big impact on cash flow and profitability. While there’s no magic number that all businesses should aim for, reducing your DSO can have many positive benefits. No matter how this measurement is used, remember that it is usually compiled from a large number of outstanding invoices, and so provides no insights into the collectability of a specific invoice. Thus, it should be supplemented with an ongoing examination of the aged accounts receivable report and the collection notes of the collection staff. For example, A/R is forecasted to be $33mm in 2021, which was calculated by dividing 55 days by 365 days and multiplying the result by the $220mm in revenue.

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