How to Calculate Days of Sales Outstanding
Master Days Sales Outstanding (DSO) to assess and improve your business's cash flow efficiency and accounts receivable management.
Days Sales Outstanding (DSO) is a financial metric that measures how quickly businesses collect payments from customers for goods or services purchased on credit. It provides insights into a company’s efficiency in managing accounts receivable, which represents money owed by customers. Understanding DSO helps businesses assess their credit policies and collection efforts, impacting their cash flow and overall financial health. It serves as a barometer for how swiftly sales convert into usable cash.
Understanding the Components of DSO
Calculating Days Sales Outstanding requires two primary financial figures: Accounts Receivable and Total Credit Sales. Accounts Receivable refers to the total amount of money owed to a business by its customers for products or services delivered but not yet paid for, typically found on the balance sheet. For an accurate DSO calculation, it is common practice to use an average accounts receivable balance over a specific period, such as 30, 60, or 90 days, to smooth out daily fluctuations.
Total Credit Sales represents the total revenue generated from sales made on credit during the same period as the accounts receivable. This figure excludes any cash sales, as cash transactions are collected immediately and do not contribute to accounts receivable.
The DSO Calculation Formula
The Days Sales Outstanding formula provides a clear method for determining the average collection period: (Accounts Receivable / Total Credit Sales) x Number of Days in Period. This formula translates the relationship between outstanding receivables and credit sales into a quantifiable number of days. The “Number of Days in Period” must align with the period for which Accounts Receivable and Total Credit Sales are aggregated, meaning 30 days for a monthly calculation, 90 for a quarterly, or 365 for an annual analysis.
For example, suppose this company had an average Accounts Receivable balance of $150,000 over a specific quarter. During that same quarter, their Total Credit Sales amounted to $900,000. For a quarterly calculation, use 90 days.
First, divide the Accounts Receivable by the Total Credit Sales: $150,000 / $900,000 = 0.1667. Next, multiply this result by the number of days in the period: 0.1667 x 90 days = 15.003 days. Therefore, this company’s Days Sales Outstanding for the quarter is approximately 15 days, meaning it takes, on average, 15 days to collect payment after a credit sale.
Interpreting Your Days Sales Outstanding
Understanding the calculated DSO number is essential for a business. A lower Days Sales Outstanding indicates that a company is efficient in collecting payments from its customers, leading to improved cash flow and liquidity. Conversely, a higher DSO suggests that it takes longer for a business to convert its credit sales into cash, which could signal issues with credit policies, collection processes, or even customer creditworthiness.
What constitutes a “good” or “bad” DSO varies significantly across different industries due to varying business models and payment terms. For example, retail businesses often have a very low DSO because most transactions are immediate, while industries like manufacturing or construction may have higher DSOs due to longer payment terms for large projects. Therefore, businesses should compare their DSO to industry benchmarks and, more importantly, to their own historical performance to identify trends. A rising DSO trend over time can act as an early warning sign of potential cash flow problems, prompting a review of credit terms or collection strategies.