How to Calculate Days in Receivables

Understanding Days in Receivables

Days in receivables, often referred to as Days Sales Outstanding (DSO), measures the average number of days it takes for a business to collect payments from its customers after a sale has been made on credit. This metric offers insight into how efficiently a company manages its accounts receivable and converts credit sales into cash.

This financial indicator reflects a company’s effectiveness in managing its credit policies and collection efforts. A lower number of days in receivables suggests that a business is efficient in collecting money owed to it, which positively impacts its liquidity. Conversely, a higher number might indicate slower collections, potentially tying up capital that could be used for other operational needs. Understanding this metric helps assess a company’s cash flow health and overall financial stability.

Information Required for Calculation

To calculate days in receivables, two financial figures are needed: net credit sales and average accounts receivable. Net credit sales represent the total revenue generated from sales made on credit, after accounting for any returns, allowances, or discounts. This figure excludes cash sales, as they do not generate accounts receivable. Businesses find total sales information on the income statement, then adjust for credit-only transactions and deductions.

Average accounts receivable is the average amount of money owed to the business by its customers over a specific period. This average is calculated by adding the accounts receivable balance at the beginning of the period to the balance at the end of the period, then dividing the sum by two. These balances are found on the company’s balance sheet. Ensure both net credit sales and average accounts receivable figures relate to the same reporting period, whether a month, quarter, or year, to maintain consistency.

Step-by-Step Calculation

Once you have gathered the financial information, calculating days in receivables involves a formula. The formula is: (Average Accounts Receivable / Net Credit Sales) Number of Days in the Period. The “Number of Days in the Period” depends on the timeframe you are analyzing, such as 365 for an annual period, 90 for a quarter, or 30 for a month.

First, determine your average accounts receivable by summing the beginning and ending accounts receivable balances for your chosen period and dividing by two. Next, identify the net credit sales for that same period.

For instance, if a company’s accounts receivable was $50,000 at the start of the year and $70,000 at the end, the average accounts receivable would be ($50,000 + $70,000) / 2 = $60,000. If the company had net credit sales of $365,000 for the year, you would then plug these values into the formula. The calculation would be ($60,000 / $365,000) 365 days. This results in 60 days, indicating it takes the company 60 days on average to collect its credit sales.

Interpreting Your Days in Receivables Figure

The calculated days in receivables figure provides insight into the efficiency of a company’s collection process. A lower number of days suggests effective credit policies and prompt collection of payments, which can enhance a company’s cash flow. Conversely, a higher number indicates that it takes longer to collect payments, potentially leading to cash flow issues as money remains tied up in accounts receivable.

What constitutes an “ideal” or “good” days in receivables figure is not universal. This metric varies across different industries and business models due to differing payment terms and customer behaviors. For example, an e-commerce business might aim for a much lower number than a manufacturing company that offers longer payment terms to its clients. For meaningful interpretation, businesses should compare their days in receivables to industry benchmarks or their own historical performance trends to gauge improvements or declines in collection efficiency.