What is Days Sales Outstanding – DSO?
Days of Sale in Progress (DSO) is a measure of the average number of days it takes a business to collect payment after the sale is made. The DSO is often determined on a monthly, quarterly or annual basis and can be calculated by dividing the amount of accounts receivable in a given period by the total value of sales on credit during the same period and multiplying the result by the number of days the period measured.
Days of sales in progress are part of the cash conversion cycle and are often referred to as days receivable or average collection period.
The formula for exceptional sales days is
TheDSO=Total credit salesAccounts receivableThe×Number of daysTheThe
What do days of exceptional sales tell you?
Due to the high importance of cash in running a business, it is in the best interest of a business to collect accounts receivable as quickly as possible. While companies can most often expect with relative certainty that they will in fact receive unpaid claims, due to the time value of money principle, the money a business spends time waiting for is lost money. By quickly turning sales into cash, a business has the opportunity to reuse money faster.
A high DSO number shows that a company is selling its product to its customers on credit and is taking longer to collect money. This can lead to cash flow problems due to the long time between the time of sale and the time the business receives payment. A low DSO value means that a business takes fewer days to collect accounts receivable. Indeed, the ability to determine the average length of time that a business’s outstanding balances are recognized in receivables can in some cases say a lot about the nature of the business’s cash flows.
It is important to remember that the DSO calculation formula only takes into account credit sales. Although cash sales can be considered to have a DSO of 0, they are not taken into account in the DSO calculations as they represent no delay between a sale and the receipt of payment by the company. If included in the calculation, they would decrease the DSO, and companies with a high proportion of cash sales would have lower DSOs than those with a high proportion of credit sales.
- Days of Sale in Progress (DSO) is a measure of the average number of days it takes a business to collect payment after the sale is made.
- DSO indicates the number of sales a business has made in a given period; the speed with which customers pay; whether the company’s collections service is working well; if the company maintains customer satisfaction or if loans are granted to customers who are not creditworthy.
- Generally, a DSO of less than 45 days is considered to be low; however, what is considered a high or low DSO can often vary depending on the type and structure of the business.
Sales in exceptional days have a wide variety of applications. It can indicate the dollar amount of sales a business has made in a given period; the speed with which customers pay; whether the company’s collections service is working well; if the company maintains customer satisfaction; or if credits are granted to clients who are not creditworthy.
While examining an individual DSO value for a business can provide a good benchmark for quickly assessing a company’s cash flows, DSO trends are much more useful than an individual DSO value. If a company’s DSO is increasing, this may indicate a few things. Customers may take longer to pay for their expenses, suggesting either that customer satisfaction decreases, that sellers within the company offer longer payment terms to increase sales, or that The company allows customers with low credit to make purchases on credit.
In addition, an excessive increase in DSO can cause serious cash flow problems for a company. If a business is used to paying expenses at a certain rate based on consistent payments to their customer accounts, a large increase in DSO can disrupt this flow and force the business to make drastic changes.
Generally, when looking at the cash flows of a given company, it is helpful to track the DSO of that company over time to determine if its DSO is trending in a particular direction or if there are trends in the company’s cash flow history. DSO can often vary on a monthly basis, particularly if the business is affected by seasonality. If a company has a volatile DSO, this can be a concern, but if a company’s DSO drops each year during a particular season, this is often less of a cause for concern.
Example of pending sales days
As a hypothetical example, suppose that during the month of July, Company A made a total of $ 500,000 in sales on credit and had $ 350,000 in accounts receivable. There are 31 days in July, the DSO of company A for July can be calculated as follows:
With a DSO of 21.7, Company A has a short average time to convert its receivables into cash. Generally, a DSO of less than 45 days is considered to be low; however, what is considered a high or low DSO can often vary depending on the type and structure of the business.
Like any measure attempting to measure the efficiency of a business, the current sales per day come with a set of limitations that it is important that any investor take into account before using it.
Put simply, when you use DSO to compare the cash flows of multiple companies, you should compare companies in the same industry, ideally when they also have similar business models and revenue figures. As mentioned above, companies of different sizes often have very different capital structures, which can greatly influence DSO calculations, and the same often holds true for companies in different industries.
The DSO is not particularly useful for comparing companies with significant differences in the proportion of credit sales, since determining the DSO of a company with a low proportion of credit sales does not say much about the cash flow from that company. Comparison of these companies with those with a high proportion of credit sales also generally does not indicate much importance.
In addition, DSO is not a perfect indicator of the effectiveness of a company’s customer accounts, as fluctuating sales volumes can affect DSO, as any increase in sales frequently reduces the value of DSO. Delinquent Days Sales Outstanding (DDSO) is a good alternative for assessing credit recovery for use with DSO. Like any measure measuring the performance of a company, the DSO should not be considered alone, but should also be used with other measures.