Assessing Days Sales Outstanding
Days sales outstanding (DSO) calculates the average number of days it takes a business to collect payment from its customers for sales. Occasionally it is also referred to as a "payment collection ratio."
The time taken to collect payment for sales—in other words, to convert accounts receivable into cash—is a useful financial indicator, particularly when compared with industry averages. It reveals the level of customer compliance with credit terms (typically 30 days net), and the efficiency of invoicing procedures. It can also uncover attempts to conceal poor sales.
Any significant change in DSO is worth a closer look. For example, a big rise could suggest that a business is agreeing to unfavorable payment terms. Or a sudden dip might reflect a discount designed to increase sales during a lean period. And if DSO is improving, it implies that a business is improving its operational efficiency.
Ideally, DSO should remain at a consistent, low level—showing that the business collects payments on sales quickly and efficiently.
Most organizations will review DSO every quarter (91 days), six months (182 days), or year (365 days). The formula is:
Suppose total accounts receivable for the period (say a quarter) are $800,000, and total credit sales are $2m. The number of days in a quarter is 91, so:
So it takes the company 36.4 days on average to convert accounts receivable into cash.
- DSO data is used with accounts receivable aging reports, which detail outstanding customer debts over four periods (0–30, 30–60, 60–90, and over 90 days). They also show the proportion of total accounts receivable in each period, with figures (derived from the profit and loss account) for potential default and bad debt.
- Note that cash sales are not included in DSO calculations—only credit sales. Sales of items other than merchandise (like fixtures, equipment, and real estate) are not included either.
- For DSO to be meaningful it needs a context, which is usually the company's own trading terms. Typically, a DSO is considered to be within reasonable limits if it exceeds terms by no more than a third to a half . So if terms are 30 days, an acceptable DSO might be between 40 and 45 days.
- Like all such calculations, a more accurate picture is obtained if DSO is reviewed regularly—a single analysis may not be representative.
- DSO varies widely between sectors. Some goods are time-limited (such as high-tech products that are quickly superseded by new models)—in which case excessive DSO could indicate problems—while others have a much longer shelf life.
- Occasionally, organizations may calculate "best possible DSO" to reveal how long it takes them to collect current receivables, using this formula:
So, if current receivables are $600,000 and total credit sales are $2,000,000, the calculation is:
Dun & Bradstreet: www.dnb.com/us