How to Calculate Days Receivable Outstanding

Days Receivable Outstanding (DRO) is a financial metric that shows how efficiently a business collects payments from customers. It indicates the average number of days it takes for a company to convert accounts receivable into cash. Understanding DRO helps businesses assess their working capital management and financial health.

Understanding Accounts Receivable

Accounts receivable (AR) represents money owed to a company by customers for goods or services delivered but not yet paid for. These are short-term debts, typically arising from credit sales. When a company extends credit, it records these future payments as accounts receivable on its balance sheet.

Managing accounts receivable impacts a business’s cash flow and liquidity. Efficient collection ensures a steady cash inflow, necessary for operational expenses, growth, or owner distributions. Poor management, leading to delayed collections, can strain a company’s cash position, even with high sales. Monitoring accounts receivable shows a company’s ability to convert sales into usable funds.

Gathering the Necessary Information

Calculating Days Receivable Outstanding requires two pieces of financial information. The first is total net credit sales for a specific period, which is revenue from credit sales after returns or allowances. This figure excludes cash sales, as they do not generate accounts receivable. Businesses find total net credit sales on their income statement, aggregated over a fiscal quarter or year.

The second piece of information is the average accounts receivable balance for that same period. To calculate this, sum the accounts receivable balance at the beginning and end of the period, then divide by two. For a yearly DRO, use the prior year’s closing balance and the current year’s closing balance. These balances are found on a company’s balance sheet.

Performing the Calculation

The calculation for Days Receivable Outstanding synthesizes the collected information. The formula divides average accounts receivable by total net credit sales for the period, then multiplies that result by the number of days in the period.

For example, consider a business with average accounts receivable of $75,000 over a fiscal year. If total net credit sales for that same year amounted to $750,000, and the period spans 365 days, the calculation is as follows: Divide average accounts receivable ($75,000) by total net credit sales ($750,000), which yields 0.10. Then, multiply this result by 365 days.

This calculation results in a Days Receivable Outstanding of 36.5 days. This figure indicates the company takes 36.5 days to collect payment from its credit customers. Ensure consistency in the period used for both sales and receivables; if using quarterly sales, the number of days in the period should reflect that quarter (e.g., 90 or 91 days).

Interpreting the Days Receivable Outstanding

The calculated Days Receivable Outstanding directly measures a company’s efficiency in collecting customer payments. A higher DRO indicates a business takes longer to collect receivables. This can lead to cash flow challenges, as funds are tied up in outstanding invoices instead of being available for operations or investments. Extended collection periods might necessitate additional short-term financing or increase the risk of bad debt.

Conversely, a lower DRO means a company collects receivables more quickly and efficiently. This indicates strong cash flow management, as funds convert from credit sales into cash faster. Businesses with lower DROs have greater liquidity and flexibility to meet financial obligations.

To assess a company’s DRO, benchmark it against industry averages or historical performance. Collection periods vary across industries; for instance, an industry with high-value, long-term contracts may have a higher DRO than one with frequent, low-value transactions. Analyzing trends in a company’s DRO over several periods can reveal improvements or deteriorations in collection practices.