Days of Sales Outstanding
Days Sales Outstanding (DSO) is a statistic used to assess a company’s ability to collect cash from consumers who purchased on credit.
DSO is the average number of days it takes a firm to recover cash payments from consumers who paid with credit – and the indicator is often reported on an annual basis for comparability.
The time period used to calculate DSO might be monthly, quarterly, or yearly. A low DSO indicates that the company requires a few days to collect its receivables. A high DSO, on the other hand, indicates that it takes more days to collect receivables.
In the long run, a high DSO may cause cash flow issues. One of the three key measures used to calculate a company’s cash conversion cycle is DSO.
Understanding of Days Sales Outstanding
The balance sheet accounts receivable (A/R) line item indicates the amount of cash due to a corporation for products/services “earned” (i.e., delivered) under accrual accounting rules but paid for with credit (when a customer has multiple days after receiving the product to actually pay for it).
A lower DSO is favored over a greater DSO because days sales outstanding (DSO) is the number of days it takes to collect due cash payments from consumers who paid on credit.
A low DSO indicates that the firm can turn credit sales into cash reasonably quickly, and receivables remain outstanding on the balance sheet for a shorter period of time before being collected.
Good and Bad DSO
DSO is important when evaluating a company’s operating efficiency because faster cash collections from customers directly lead to increased liquidity (more cash), which means more free cash flows (FCFs) that could be reallocated for different purposes rather than being forced to wait on the customer’s payment.
If DSO rises over time, it indicates that the corporation is taking longer to receive cash from credit sales. DSO lowering, on the other hand, indicates that the organization is getting more efficient at cash collection and hence has greater free cash flows (FCFs).
Remember that an increase in an operational working capital asset equals a decrease in FCFs (and the reverse is true for working capital liabilities).
However, a rise in A/R implies a cash outflow, whereas a drop in A/R reflects a cash inflow because it means the firm has been paid and hence has greater liquidity (cash on hand).
- Low DSO = Efficient Credit Sales Cash Collection (Higher Free Cash Flow)
- High DSO = Ineffective Credit Sales Cash Collection (Lower Free Cash Flow)
As a general rule, businesses try to reduce DSO since it suggests that the existing payment collecting technique is efficient.
Days Sales Outstanding Formula
The following formula is used to determine how many days it takes on average for a company’s accounts receivable to be recognized as cash:
Days Sales Outstanding (DSO) = Accounts Receivables / Net Credit Sales x Number of Days
Days Sales Outstanding Example
Assume you own a company with $25,000 in accounts receivable (A/R) on January 1st, 2022. Then, on February 1st, 2022, that sum was increased to $20,000. Furthermore, suppose you sell $45,000 on credit during that time period.
To get your DSO, first determine your average A/R for the time period. Your average A/R is $22,500, which is the average between $25,000 and $20,000 in this situation.
The next figure you’ll need is your Total Credit Sales, which was provided as $45,000.
Finally, calculate the number of days in the period. Because September has 30 days, we’ll choose 30 for the Number of Days.
DSO = Average Accounts Receivables / Net Credit Sales x Number of Days
DSO = 22500/45000 x 30
DSO = 15
This DSO calculation shows that it takes this example company 15 days (on average for this time period) to collect on a credit sale, which is quite good for most sectors.
In general, a DSO of less than 45 is considered modest, however, this is highly dependent on your organization and sector. Do some study in your sector to understand what is considered a “standard” DSO for you.
Importance of DSO
Calculating the number of days sales outstanding is a useful technique for assessing the liquidity of a company’s current assets. Because cash is so important in business, it is in the company’s best interests to recover receivable amounts as soon as feasible.
Managers, investors, and creditors evaluate the company’s ability to recover cash from consumers. A lower DSO score indicates a strong level of liquidity and cash flow.
How to Improve Days Sales Outstanding (DSO)
However, if your DSO might need some work, don’t give up. A few tweaks to your collecting methods might make all the difference. You may boost your DSO by doing the following:
- Whenever feasible, collect money in advance: Many of your consumers will not hesitate to pay in advance. All you have to do is inquire!
- Giving your consumers a variety of payment options: Most clients are willing to pay you for your services, but you must make it easy for them! Make sure you take both credit cards and eChecks.
- Payments should be as automatic as possible: If your consumers must speak with someone in your company to pay an invoice, you are restricting their alternatives and wasting their time. Set up regular online payments so that your company can automatically collect bills.
Days Sales Outstanding Vs Accounts Receivable Turnover
Cashflow is the lifeblood of every firm, and accounts receivable (A/R) turnover is the beating heart that keeps the money coming. It is critical for cash flow to optimize your collection process.
The better you optimize collecting methods and tasks, the more efficient and productive your A/R department will be.
Receivables turnover gauges the efficiency with which your organization collects income. It reflects how successfully A/R handles extended credit and the efficiency of its processes.
The formula for calculating Receivables turnover is as follows:
Receivables turnover = Net Credit Sales/Account Receivables
Days sales outstanding is a measure that represents the amount of time it takes your organization to receive income from a client or customer following the sale.
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