Days Sales Outstanding (DSO) refers to the average number of days a company takes to collect its payments from the creditors. In other words, DSO is the time taken by a company to collect its accounts receivable. DSO is always computed monthly, quarterly, or annually depending on the duration the company finds useful for its operations.
In reference to time value for money concept and the money circulation in the economy, companies prefer to collect their payments as quickly as possible once sales have been made. This helps in reducing the depreciation in the value of the currency as a result of inflation, among other factors.
Days Sales Outstanding is one of the three metrics companies deploy in evaluating the cash flow cycle. It reports how fast a company is collecting on accounts receivable within a given period. Managers can use this concept to assist them in tracking the trends of their creditors. Also, it would allow them to assess the creditworthiness of the customers.
Days Sales Outstanding Formula
$$\text{Days Sales Outstanding} = \dfrac{\text{Accounts Receivable}}{Total\: Credit\: Sales}\: \times \:Number\: of\: Days$$
If possible, use the average accounts receivable during the period to factor in the fluctuations in sales volume. The number of days in the period can be monthly, quarterly, or annually depending on which period the company considers to be useful.
When you are using information published at the end of the financial year by a company, then the ending accounts receivable is used. Credit sales are rarely found in the financial statements, so the company always provides these figures
There’s no absolute number for a good DSO because it varies by industry and the underlying payment terms. A high DSO indicates that the company is taking longer to collect their payments from the creditors, while a low DSO shows that the collection of payment is done frequently and quickly.
DSO, to some extent, can be used to assess the creditworthiness of the creditors; for instance, a situation whereby the creditor delays the collection, one can say that they are financially stressed.
This, in turn, reduces the cash flow of the company. DSO of above 45 days is considered high in a normal situation. However, DSO tends to vary depending on the nature and structure of the business so, generally speaking, high and low DSO is relative considering the nature and structure of the business and across different areas and regions.
Sometimes annual economic fluctuations can affect your calculation, so it’s not a perfect indicator. In this situation, delinquent days sales outstanding (DDSO) is a good alternative. Due to these limitations, companies should not use DSO alone as a measure of a company’s performance. And like any metric used in gauging a business’ efficiency, DSO should only be used to compare companies within the same industry.
Days Sales Outstanding Example
ABC Limited registered a sales revenue worth $800,000 for June 2018. Out of the $800,000 sales revenue, $300,000 were cash sales while the rest were credit sales. The account receivable balance was $400,000 at the end of that month. Compute day’s sales outstanding of ABC Limited.
Now let’s break it down and identify the values of different variables in the problem.
- Accounts receivable = $400,000
- Total Credit Sales = ($800,000 – $300,000) = $500,000
- Number of Days = 30 days
Now, we can apply them to our formula:
$$\text{Days Sales Outstanding} = \dfrac{\text{Accounts Receivable}}{Total\:Credit\:Sales}\: \times \:Number\:of\:Days$$
$$\text{Days Sales Outstanding} =\dfrac{\$400{,}000}{\$500{,}000}\: \times \:30 = 24\: days$$
From the information provided above, ABC Limited’s days sales outstanding would be 24.
This means that, on average, ABC Limited takes 24 days before they collect their payments from the creditors. A DSO of 24 is below the typical 45 days. Without considering the type and structure of the business, we can say that ABC Limited is doing very much fine, and they have high chances of expanding their business as they have constant cash flow. They reinvest back the received amounts to increase production.
Days Sales Outstanding Analysis
Days Sales Outstanding helps you understand the liquidity of a company’s current assets. For instance, a high DSO might suggest that consumers are not satisfied with the product. Sales per day are decreasing, making it difficult for sales to be converted into cash. It can increase your accounts receivable, leaving them to be written off as bad debts.
High DSO makes companies less risk-averse with time. As a result, companies are not able to pay operational costs such as workers’ salaries, the cost of raw materials, etc. In consequence, analysts differ on this issue. They argue that high DSO may be due to the nature and structure of the business. Therefore, companies with large capitalization might have a low DSO that a smaller-sized company would consider high.
A low DSO shows that companies are collecting their payments as fast as possible. Therefore, there is more money in their hands. This translates to greater efficiency in credit sales collection. This may benefit small and medium-sized companies in paying their operational expenses. They could reinvest the extra cash received to expand the business. This can help them to avoid write-offs in their accounts receivable.
It’s better to track your DSO monthly for a more consistent measure of a creditor’s creditworthiness. It also speeds up the process for analysis and reevaluation of terms. Also, due to typical fluctuations in sales, a monthly DSO can give a better picture of trends.
Days Sales Outstanding Conclusion
- Days sales outstanding is the average number of days a company takes to collect payments from creditors.
- This formula shows the total value of credit sales a company has made within a specific period.
- A high value may indicate they’re collecting account receivable too quickly.
- A low value is preferred as it maintains the company’s cash flow.
- Compare a company’s days sales outstanding to past financial ratios or to companies within their industry.
- This formula requires two variables: Net credit sales and Average accounts receivable.
Days Sales Outstanding Calculator
You can use the days sales outstanding calculator below to quickly calculate the average number of a company is collecting its accounts receivable within a given period by entering the required numbers.