Days Sales Outstanding DSO

Offering an incentive, such as a discount for prompt payment within ten days or making upfront payments, can incentivize customers to prioritize your invoices. A low Days Sales Outstanding (DSO) is generally considered a positive indicator of the health of your accounts receivable process (check out our article on accounts receivable KPIs for other ways to track this). The following video provides a good explanation of days sales in receivables or days sales outstanding.

A low DSO number generally means that it takes the company less time to collect payments. Although it varies depending on the business type and structure, DSO numbers under 45 days are considered low. A low DSO value may also indicate that customers are paying on time or even early to benefit from discounts or the company has a very strict credit policy in place. Every business is different and, consequently, there is no set DSO amount that indicates good or bad accounts receivable management. If your average accounts receivables don’t align with the cash it takes to run your operations, you could find yourself in a situation where you can’t keep pace with business growth.

What is the Days Sales Outstanding Calculation?

So on day 1, the company takes delivery of materials for 10 chairs and sells all 10 to consumers and still has $100 in the bank. Most companies are not in this situation, so in order to avoid having production constrained by free cash, it is desirable to minimize the difference between AR Days and AP days. This ratio is important because it means Apple can effectively ramp up production to the very maximum level of consumer demand and will never be limited by cash flow (not that it would be anyway with $100bn in the bank). For the purpose of this calculation, it is usually assumed that there are 360 days in the year (4 quarters of 90 days).

• Therefore, it is best to review an aging of accounts receivable by customer to understand the detail behind the days’ sales in accounts receivable ratio.
• Days sales outstanding is an element of the cash conversion cycle and may also be referred to as days receivables or average collection period.
• Generally, a DSO below 45 is considered low, but what qualifies as high or low also depends on the type of business.
• Furthermore, DSO can also be used to examine the company’s overall efficiency and profitability.
• 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.

The lower the DSO value, this implies that the firm takes a shorter duration to convert their credit sales into capital, thereby suggesting a healthier cash flow. Conversely, the larger the DSO ratio, the greater the period taken by the client to settle its outstanding accounts receivables, thus shedding light on a possibly tighter operational cash flow for the company. As a result, the firm would be able to devise the relevant strategies to lower the DSO value. Days sales outstanding (DSO) is the measurement of the average number of days it takes a business to collect payments after a sale has been made.

How do you calculate DSO?

In accountancy, days sales outstanding (also called DSO and days receivables) is a calculation used by a company to estimate the size of their outstanding accounts receivable. Losing revenue puts you in a vulnerable position because you may have to seek outside financing to increase your cash flow. If you don’t have the funds to pay your monthly operating expenses, your interest payment may increase your cash burden. If you hire a collections company to collect outstanding receivables, they may ask for a percentage of the balance. Days Sales Outstanding is often confused for “the time it takes to fully collect unpaid invoices.” Mathematically, there is no direct relationship between DSO and the number of days it takes a company to get paid. DSO is a measurement of the number of an average day’s sales that are tied up in receivables awaiting collection.

Business acquirers use the calculation to find companies with high DSO values, with the intention of procuring the business and improving their collection and credit processes. Finally, DSO is a crucial calculation to analysts who are looking to compare companies to see how well they manage credit and use receivables to grow their business. The differences between days sales outstanding and average collection period are nuanced and dependent on your industry.

The point of the measurement is to determine the effectiveness of a company’s credit and collection efforts in allowing credit to reputable customers, as well as its ability to collect cash from them in a timely manner. The measurement is usually applied to the entire set of invoices that a company has outstanding at any point in time, rather than to a single invoice. When measured at the individual customer level, the measurement can indicate when a customer is having cash flow troubles, since it will attempt to stretch out the amount of time before it pays invoices. Accounts receivable refers to the outstanding balance of accounts receivable at a point in time here whereas average sales per day is the mean sales computed over some period of time.

Forecasting Accounts Receivable Using DSO

To determine your net credit sales, take your total sales made on credit terms and subtract any returns or sales allowances. Having mentioned that, different businesses may have varying definitions of what “quickly” would mean. For instance, having an extended credit period is considered to be fairly common in the world of finance. However, secured debt settlements are critical for the energy and agriculture sectors. Other than that, smaller firms are typically more dependent on having a stable and positive cash flow compared to large multinational corporations, which may have a diverse range of revenue streams. That’s why most CFOs and finance professionals use this method to calculate their company’s DSO and that’s why you should use it too.

• The period of time used to measure DSO can be monthly, quarterly, or annually.
• As a general rule of thumb, companies strive to minimize DSO since it implies the current payment collection method is efficient.
• In theory, a company or a sector that is accustomed to selling on credit will have a higher DSO.
• In other words, it shows how well a company can collect cash from its customers.
• – In general, having a DSO below 45 days is considered low and a good target for corporations to achieve.

This is more easily said than done, but with time and experience, companies can become better at determining high-risk customers. Finance professionals at the company can then determine the credit limit for those customers or decide if they should receive any credit at all. This could save the finance team thousands of dollars in man-hours and unpaid debt.

Incentivize early payments

Days Sales Outstanding is also known as “days receivable”, “average collection period”, or “average debtor days”. It is calculated to find out the average number of days a company takes to collect the dues owed by other individuals and companies. In addition to DSO, you should be analyzing collections metrics, accounts receivable metrics, and financial ratios, like your accounts receivable turnover ratio, AR aging, average days delinquent, bad debt to sales, and more. And you should be customizing those metrics according to the unique nuances of your business. In essence, companies with a high DSO ratio imply that they are spending a lot of time waiting for the customers on credit to repay their debts.

Once you have these two numbers for each month, you compare them to each other going back in time. To calculate the DSO, we divide his total $200,000 AR by his net credit sales of $150,000. Trade credit insurance remains one of the most efficient solutions to ensure the stability of your DSO. With trade credit insurance, you are insured in the event that a credit cannot be recovered. As a result, you are guaranteed that a potential bad debt will not have a negative impact on your working capital. Read our article on how credit insurance helps to secure your cash flow to learn more.

The ratio is used to evaluate the ability of a company to efficiently issue credit to its customers and collect funds from them in a timely manner. A modern AR automation platform can be your business’ lifeline when it comes to staying on top of days sales outstanding and maintaining control of your cash position. Learn more about how you can streamline quickbooks review your accounts receivable operations with automation here. A low DSO number means that it takes your company a reasonably short time to collect payment from customers paying on credit terms. A high DSO number means that it takes your company longer to collect from these customers and could potentially signal inefficiencies in your collections processes.

Not only does automation improve the days to collect, but it may help you to avoid a high DSO. The accounts receivable turnover ratio and DSO are two important metrics for measuring a business’s financial health. While these metrics may seem similar at first glance, they actually measure different things. The days sales outstanding calculation, also called the average collection period or days’ sales in receivables, measures the number of days it takes a company to collect cash from its credit sales. This calculation shows the liquidity and efficiency of a company’s collections department.

Determining the days sales outstanding is an important tool for measuring the liquidity of a company’s current assets. Due to the high importance of cash in operating a business, it is in the company’s best interests to collect receivable balances as quickly as possible. Managers, investors, and creditors see how effective the company is in collecting cash from customers. Since days sales outstanding (DSO) is the number of days it takes to collect due cash payments from customers that paid on credit, a lower DSO is preferred to a higher DSO. By tracking DSO proactively, your AR team will have a reliable pulse on how the company is maintaining these priorities. Days sales outstanding (DSO) can be defined as the mean number of days a company takes to have its clients repay their debts for a previous sales transaction.

During this waiting period, the company has yet to be paid in cash despite the revenue being recognized under accrual accounting. To interpret this metric, we will need details on the company’s industry and past data. A good or bad DSO ratio may vary according to the type of business and industry that the company operates in.

Global E-Invoicing and Payment Software

Not every customer is going to be the right fit, so it’s important for the health of your cash flow to identify at-risk customers early and take action to bring them back on track—or walk away. If you want to calculate your DSO for the quarter, take your total receivables for those 3 months, divide them by your total net credit sales during that period and multiply the quotient by the number of days in the period. For instance, if you were calculating your DSO for January to March, you would multiply the quotient by 90 days. To calculate your DSO for a given period (a single month for instance) you’ll need to know your total receivables and total net credit sales.

Therefore, it is best to review an aging of accounts receivable by customer to understand the detail behind the days’ sales in accounts receivable ratio. There are a couple of reasons your days sales outstanding could be trending higher. It could be an indication that customer satisfaction is low and as a result, customers are taking their time to pay you. In that case, your sales team is likely extending credit to customers they shouldn’t. Alternatively, analysts may want to consider other metrics, such as the delinquent days sales outstanding (DDSO) together with the DSO ratio, as part of investigating a company’s credit collection capabilities and efficiency.