Days Sales Outstanding or DSO is a Key Performance Indicator, measuring the health of the Accounts Receivable.
In its most simplistic form, DSO is a measure of how quickly, on average, a company is collecting payments from its customers. It measures how quickly credit sales are being turned into cash flow. Another way of looking at DSO is that it measures the impact of payment terms on the operational cycle of a business, as longer payment terms have a larger impact on the DSO calculation.
Days Sales Outstanding (DSO) may be measured over differing lengths of time, with larger periods giving a more stable calculation. Many companies measure DSO over a month, quarter or on an annual basis.
DSO offers insights into how the business is performing;
- Total number of sales in a specificed period.
- Overall performances of the accounts receivable team.
- Operational performance and liquidity of the company.
- Customer payment behavior and relationships.
What does a High Days Sales Outstanding or Low Days Sales Outstanding indicate?
A high DSO may indicate one of the following:
- Business has a customer base that do not pay to terms.
- Customers have been offered extended payment terms.
- Collection practices and procedures are not impactful and require updating.
Alternatively, a low DSO may indicate one of the following:
- Business has a customer base that generally pay to terms.
- Business has standard terms with few extended terms granted.
- Collection practices and procedures are impactful.
One thing to pay attention to is the inputs to the DSO calculation. Having a high or low DSO can be impacted greatly if either of the accounts receivable or sales are unusually high or low. An example would be for many seasonal orders to be released on extended payment terms, greatly increasing the sales and accounts receivable number. In month two, when the revenue is back to normal values, the accounts receivable would remain high, thus increasing the DSO number, not because of poor collections, but due to the business terms.
The DSO Calculation
There are a few different ways to calculate DSO. The first, an most often utilized method is the balance sheet method. In the balance sheet method you will need the following information;
- Value of Accounts Receivable at the end of the period being measured.
- Number of days in the period being measured.
- Value of sales during the period being measured.
Formula: Accounts Receivable / Sales, times the number of days in period.
Example; 10,000 (Accounts Receivable) / 15,000 (Sales), times 91 (Days in a 3-month period) = 60.7 days DSO.
The second method to calculate DSO is the rollback method. Begin with the most recent months sales and count backwards the number of days until the sales number is exhausted. In this method you will require the following information;
- Values of the Accounts Receivable at the end of the period being measured.
- Values of the sales in each period.
- Number of days in each period.
Formula: Accounts Receivable of Period / Sales, times the number of days in period.
Example: 10,000 (Accounts Receivable), March Sales 5,000, April Sales 4,000, May Sales 5,000 = March Sales Exhausted = 31 days. April Sales Exhausted = 30 days. May Sales 10,000 / Accounts Receivable Left 1,000 * 30 days in period = 3 days. 31 + 30 + 3 = 64 days DSO
For instances where the accounts receivable often fluctuates, there is the average DSO method. For this method you will require;
- Value of accounts receivable at start of period being measured.
- Value of accounts receivable at the end of the period being measured.
- Value of sales during the period being measured.
- Number of days in the period being measured.
Formula: Average Accounts Receivable / Sales, times the number of days in the period.
Example: 10,000 (Starting Accounts Receivable) + 20,000 (Ending Accounts Receivable) / 2 = 15,000 Average Accounts Receivable / 30,000 (Sales in period) * 30 (days in period) = 15 days DS
