Days’ Sales Outstanding
Days Sales Outstanding (DSO) is a financial ratio that measures the average number of days it takes a company to collect payment after a sale has been made. It’s a measure of the effectiveness of a company’s credit and collection policies, as well as its cash flow management.
The formula for DSO is as follows:
\(\text{Days Sales Outstanding} = \frac{\text{Accounts Receivable}}{\text{Total Credit Sales}} \times 365 \)
Where:
- Accounts Receivable” is the money that is owed to the company by its customers for goods or services that have been delivered or used but not yet paid for.
- Total Credit Sales” refers to the total sales made on credit (not including cash sales) during the same period.
The resulting number tells you, on average, how many days it takes for a company to collect payment after a sale has been made.
A lower DSO is generally better, as it indicates that a company can quickly collect its receivables, which benefits its cash flow. This could be a sign of efficient credit and collections policies, and/or that the company’s customers are generally prompt payers.
On the other hand, a higher DSO means that a company takes longer to collect its receivables. This could suggest issues with the company’s credit policies or collections practices, and/or that its customers are slow to pay their bills. A high DSO can tie up a company’s cash in receivables, which could potentially strain its cash flow.
As with all financial ratios, DSO should be compared with industry norms and historical performance to provide meaningful insights.
Example of Days’ Sales Outstanding
Let’s consider a hypothetical example of a company.
Suppose for the current fiscal year, the company reported:
- Accounts Receivable: $400,000
- Total Credit Sales: $3,000,000
We can calculate the Days Sales Outstanding (DSO) as follows:
\(\text{DSO} = \frac{\text{Accounts Receivable}}{\text{Total Credit Sales}} \times 365 \)
\(\text{DSO} = \frac{\$400,000}{\$3,000,000} \times 365 = \text{approximately 48.7 days} \)
This means that, on average, it takes the company about 49 days to collect payment after a sale has been made.
To interpret this DSO, the company would need to compare it with its own DSO from previous years, as well as with the DSOs of other companies in the same industry.
For instance, if the industry average DSO is 40 days, this company is taking longer than its competitors to collect its receivables, which could suggest issues with its credit policies or collections practices. On the other hand, if the company’s DSO was 60 days the previous year, the current DSO of 49 days could indicate an improvement in its ability to collect receivables.
