How to Calculate Days Sales Outstanding

Days Sales Outstanding (DSO) is a financial metric that businesses use to measure the average number of days it takes to collect revenue after a sale. Understanding DSO helps businesses assess their liquidity and ability to meet financial obligations.

Understanding Days Sales Outstanding

Days Sales Outstanding measures a company’s efficiency in managing its accounts receivable, which is money owed by customers for goods or services delivered. It indicates how effectively a business collects payments from customers who purchase on credit. A low DSO suggests quick payment collection, improving liquidity and working capital. This allows a business to have cash readily available for operations, investments, or debt repayment.

Conversely, a high DSO suggests a longer time to collect receivables. This can tie up working capital, potentially leading to cash flow challenges for the business. The metric helps assess the effectiveness of a company’s credit policies and collection efforts.

Gathering Information for Calculation

To calculate Days Sales Outstanding, specific financial data is required for a defined period, such as a month, quarter, or year. The primary figures needed are total credit sales for that period and the accounts receivable balance at the end of the same period. Total credit sales represent the total value of goods or services sold on credit, excluding any cash sales or returns, and are typically found on a company’s income statement.

Accounts receivable, which is the total amount of money owed to the company by its customers, is usually located on the balance sheet at the end of the chosen period. It is important to specifically use credit sales rather than total sales to ensure an accurate DSO calculation, as cash sales do not involve a collection period.

Step-by-Step Calculation

The formula for Days Sales Outstanding is: (Accounts Receivable / Total Credit Sales) × Number of Days in Period. “Accounts Receivable” is the total outstanding amount owed by customers at the end of the chosen period. “Total Credit Sales” refers to the entire value of sales made on credit during that same period. The “Number of Days in Period” refers to the specific duration being analyzed, such as 30 days for a month, 90 days for a quarter, or 365 days for a year.

For example, if a company has $150,000 in accounts receivable at the end of a quarter and recorded $450,000 in total credit sales during that quarter, the calculation would proceed as follows. Since a quarter typically has 90 days, the formula becomes ($150,000 / $450,000) × 90. This simplifies to approximately 0.3333 × 90, which results in a DSO of about 30 days.

Interpreting Your DSO Result

A high DSO indicates that a company is taking a longer time to collect payments, which can strain cash flow. For instance, a DSO of 60 days when industry average is 30 days might suggest lenient credit terms or inefficient collection processes. This can lead to less available cash for operational expenses or new investments.

Conversely, a low DSO suggests that a company is efficiently collecting its receivables, meaning cash is flowing into the business more quickly. A DSO of 20 days, for example, shows strong cash management. What constitutes a “good” or “bad” DSO is relative and depends on industry benchmarks, a company’s credit terms, and prevailing economic conditions. Comparing a company’s DSO to its industry peers or its own historical trends can provide more meaningful insights into its financial health.