Days Sales Outstanding: What It Is and Why It Matters

Days sales outstanding (DSO) is defined in this article along with its calculation. We also go through its significance in relation to other metrics, compare high and low DSOs, and examine how organizations can use this formula to enhance their invoicing

The term “days sales outstanding,” or DSO, refers to the typical number of days it may take a business to collect payment for a transaction. The majority of businesses should calculate this ratio, since it shows how many days a company may carry debt before it negatively impacts cash flow.

In addition, some lenders feel that you can tell reliable businesses from those who might have credit problems by learning how to calculate DSO and using it to gauge staff productivity and cash flow efficiency.

What is Days Sales Outstanding?

Accountants use a method called “days sales outstanding” to calculate the size of an organization’s outstanding accounts receivable. This calculation can be performed by accountants on a monthly, quarterly, or annual basis.

The outstanding balance of accounts receivable at a particular period is referred to as accounts receivable and can tell you a lot. For instance, if a business’ DSO is rising, this can point to a possible drop in customer satisfaction or the possibility that a sales team is regularly making credit sales. A low DSO simply means that a business is quickly receiving payment following a transaction, enabling it to reinvest that money in ongoing business activities faster.

DSO can be used by businesses to spot cash flow inefficiencies and evaluate potential financial concerns. When businesses assess DSO on an individual basis, a high ratio could be a sign that a client is having trouble making a payment. This indicator can be used by accountants and business owners to assess the financial commitment made to receivables.

Calculating DSOs

To calculate your business’ DSO, you can divide the total number of accounts receivable during a period by the total dollar value of credit sales, then multiply that value by the number of days in that period.

You can use this formula to calculate DSO:

DSO = (accounts receivable / total credit sales) ∗ number of days

For example, if a company had an accounts receivable balance of $30,000, and an annual sales of $750,000, then you can find the company’s DSO with the formula:

DSO = (30,000 / 750,000) ∗ 365 days per year = 14.6 days outstanding sales

Why Days Sales Outstanding Matters

Days Sales Outstanding (DSO) is a crucial metric for assessing liquidity. Due to its ability to shed light on how successfully a firm can meet its short-term obligations, a company’s liquidity is frequently of importance to investors.

Companies may use a DSO ratio to determine whether their payment conditions warrant a change in their credit policy. DSO can assist businesses in coordinating the amount of credit they wish to extend to consumers with their collection processes.

Metrics Used With Days Sales Outstanding Figures

Companies must keep in mind that variables like changes in sales can impact DSO in order to maintain accurate reports. DSO may exhibit a declining tendency throughout the duration of the winter holidays, for instance, when revenues may not be typical of an average month. The following metrics can be used in conjunction with DSO to increase the effectiveness of the collection processes:

Delinquent DSO

This statistic, which is also known as average days delinquent or ADD, is frequently used by businesses to assess the efficacy of their collection efforts. It serves as an additional tool that helps businesses assess how well they can turn revenues into profits.

By figuring out DSO, dividing current receivables by annual credit sales, and multiplying by 365, you can figure out ADD. The outcome is the best days sales outstanding (BPDSO), which is ideal. The average days delinquent are obtained by subtracting the BPDSO from the DSO, as indicated in the following formula:

ADD = DSO – BPDSO

Collections Effectiveness Index

The ability of collection staff to collect outstanding debt from clients following a sale is gauged by the collections effectiveness index, or CEI. The collections effectiveness index can be used to evaluate how well the process is running, whereas DSO monitors the amount of time it takes to collect revenue from a sale. The CEI formula is as follows:

CEI = ([(beginning receivables + monthly credit sales − ending total receivables) / (beginning receivables + monthly credit sales − ending current receivables)] ∗ 100

A value of above 80% represents an effective collections process, whereas a value of below 50% might be a cause for concern.

What Does a High DSO Figure Indicate?

A business takes longer to collect accounts receivable if its DSO is high. Customers who frequently pay late may indicate that the company’s credit policy is confusing or that the collection process is ineffective. Companies must investigate payment delays in order to develop practical solutions. Here are some reasons a business could have a high DSO:

• Decreasing levels of client satisfaction
• Ineffective collection techniques
• Ambiguous credit policy
• Sales representatives are extending payment terms to boost sales to uncreditworthy customers

What Does a Low Days Sales Outstanding  Figure Indicate?

A low DSO suggests that a company’s collection process is efficient, and that their customers make payments promptly using an effective credit policy. DSO is low when the formula yields a value below 45.

Besides having a successful collections model, companies might calculate a low DSO because of their relatively high net sales value. This might indicate either a lenient credit policy or inadequate risk assessment.

How to Reduce Your DSO Numbers

Get Invoices Out Faster

A business can shorten the time between sales and payment by producing faster and more effective invoices. Businesses can offer customers rewards for making payments early, such as a 1 percent discount if the payment is made within ten days.

Enforcing – rather than just threatening – late penalties and embracing a wider range of quick payment options are two more strategies for reducing the period between sales and payment.

Make Invoicing More Efficient

It’s important for businesses to have an accurate and efficient invoicing process to create a consistently low DSO ratio. Establishing clear and accessible billing terms can help companies maintain strong customer relationships and avoid discrepancies with payment options and contracts. They can also create clear and detailed invoices to help ensure customers fully understand each product and service.

Stay on Top of Basic Accounting

Days Sales Outstanding is just one of a number of small business accounting metrics you need to stay on top of, not just in order to calculate how much money you are making, but also to grow your business in the way you’d like.

However, as a small business owner you may not have the time, resources or the inclination to pay as much attention to your accounting as you should. Working with a small business accountant changes all of that, and the investment you make in their services will pay for itself multiple times over, fast. Contact us today to learn more about how our services can help your business.