Days Sales Outstanding Guide: How to Understand DSO

Days Sales Outstanding (DSO) is an accounting ratio that companies use to compare the balance of accounts receivable to the revenue a company makes over a given amount of time. It reflects the average number of days that a company spends to collect funds from unpaid invoices. DSO is a good indication of how quickly your company collects payment on items in accounts receivable for services rendered or goods provided to customers or creditors.

In general, the lower a company’s DSO ratio, the better. A DSO number of 45 and below is considered low and ideal. Low DSO value means that a company is collecting payments on time for their sales. In contrast, a high DSO means that there are too many days elapsing between when a sale is made and when the payment is collected, resulting in a low cash conversion cycle and potentially bad debt. A high DSO number can also forecast a deficit of working capital, especially if you have a small business.

The Days Sales Outstanding formula is (accounts receivable/ total credited sales) x Number of days in the accounting period. To calculate your days sales outstanding ratio, you need to divide your accounts receivable balance by the dollar amount of sales you made. Next, multiply that by the number of days in the period of time you’re measuring for.

For example, if a business made one million dollars in total credit sales but had $400,000 in accounts receivable and is being calculated for the month of September (30 days), the formula would be: 400,000/1,000,000 x 30 = 12 days. This means that this business takes about 12 days to collect its accounts receivable items.

DSO calculations are often blended with other financial ratios and metrics to better understand how business is going. DSO on its own, however, can serve your business in the following ways.

1. 1. It can provide a general idea of financial operations. If your business has payment terms that are too long or a poor collections process, it may cause cash flow problems and impact profitability or liquidity over time. DSO calculations can help identify these issues so that you and your accounting department can better adjust your credit policies to maximize profitability and payment. However, DSO is not an entirely accurate representation of a company’s accounts receivable process. For instance, DSO calculations don’t account for a company’s cash sales (which are completed immediately), which means it won’t be able to provide a larger financial picture for your business.
2. 2. They can indicate customer satisfaction. Happy customers often return for additional purchases and pay for their goods on time. If you have a lower average DSO, it means that customers are receiving their goods and paying for them, with minimal refunds or returns. Higher DSO can indicate that some customers are not satisfied with their products, or perhaps have poor credit and simply cannot pay. It can also indicate that your credit terms are too strict and leading to more negative experiences amongst customers.
3. 3. They can measure performance. DSO calculations are a metric that works when you compare businesses within a specific industry, allowing you to compare your sales to competing companies. However, DSO cannot compare performances across different industries, as each has its own fiscal benchmarks.

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