What Is Days Sales Outstanding (DSO)?
Days sales outstanding (DSO) is a measure of the average number of days that it takes a company to collect payment for a sale. DSO is often determined on a monthly, quarterly, or annual basis.
The days sales outstanding formula is as follows: Divide the total number of accounts receivable during a given period by the total value of credit sales during the same period and multiply the result by the number of days in the period being measured.
Day Sales Outstanding
Understanding Days Sales Outstanding
Given the vital importance of cash flow in running a business, it is in a company's best interest to collect on its outstanding account receivables as quickly as possible. Companies can expect with relative certainty that they will, in fact, be paid their outstanding receivables. But, because of the time value of money principle, money spent waiting to be paid is money lost.
By quickly turning sales into cash, a company has a chance to put the cash to use again more quickly.
That said, the definition of "quickly" depends on the business. In the financial industry, relatively long payment terms are common. In the agriculture and fuel industries, fast payment can be crucial. In general, small businesses rely more heavily on steady cash flow than large, diversified companies.
What the Numbers Tell You
A high DSO number shows that a company is selling its product to customers on credit and waiting a long time to collect the money. This can lead to cash flow problems. A low DSO value means that it takes a company fewer days to collect its accounts receivable. That company is promptly getting the money it needs to create new business.
In effect, determining the average length of time that a company’s outstanding balances are carried in receivables can reveal a great deal about the nature of the company’s cash flow.
It is important to remember that the formula for calculating DSO only accounts for credit sales. While cash sales may be considered to have a DSO of 0, they are not factored into DSO calculations. If they were factored into 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 sales outstanding (DSO) is the average number of days it takes a company to receive payment for a sale.
- A high DSO number suggests that a company is experiencing delays in receiving payments. That can cause a cash flow problem.
- A low DSO indicates that the company is getting its payments quickly. That money can be put back into the business to good effect.
- Generally speaking, a DSO under 45 days is considered low.
Applications of Days Sales Outstanding
Days sales outstanding can be analyzed in a wide variety of ways. It indicates the dollar amount of sales a company has made on credit during a specific time period. It suggests how efficient the company's collections department is, and the degree to which the company is maintaining customer satisfaction. It also helps identify customers that are not creditworthy.
Looking at a DSO value for a company for a single period can provide a good benchmark for quickly assessing a company’s cash flow. However, trends in DSO over time are much more useful. They can act as an early warning sign of trouble.
Good and Bad DSO Numbers
If a company’s DSO is increasing, it's a warning sign that something is wrong. Customer satisfaction might be declining, or the salespeople may be offering longer terms of payment to drive increased sales. Or the company may be allowing customers with poor credit to make purchases on credit.
A sharp increase in DSO can cause a company serious cash flow problems. If a company's ability to make its own payments in a timely fashion is disrupted, it may be forced to make drastic changes.
Generally, when looking at a given company’s cash flow, it is helpful to track that company’s DSO over time to determine if its DSO is trending up or down or if there are patterns in the company’s cash flow history.
DSO may vary consistently on a monthly basis, particularly if the company's product is seasonal. If a company has a volatile DSO, this may be cause for concern, but if its DSO regularly dips during a particular season each year, it could be no reason to worry.
Example of Days Sales Outstanding
As a hypothetical example, suppose that during the month of July, Company A made a total of $500,000 in credit sales and had $350,000 in accounts receivable. There are 31 days in July, so Company A’s DSO for July can be calculated as:
With a DSO of 21.7, Company A has a short average turnaround in converting its receivables into cash. Generally speaking, a DSO under 45 days is considered low. However, what qualifies as a high or low DSO may vary depending on the business type and structure.
Limitations of Days Sales Outstanding
Like any metric attempting to gauge the efficiency of a business, days sales outstanding comes with a set of limitations that are important for any investor to consider before using it.
When using DSO to compare the cash flows of a number of companies, one should compare companies within the same industry, ideally when they have similar business models and revenue numbers. Companies of different sizes often have very different capital structures, which can greatly influence DSO calculations. The same is true of companies in different industries.
When DSO Is Not As Relevant
DSO is not particularly useful in comparing companies with significant differences in the proportion of sales that are made on credit. The DSO of a company with a low proportion of credit sales does not indicate much about that company’s cash flow. Comparing such companies with those that have a high proportion of credit sales also says little.
In addition, DSO is not a perfect indicator of a company’s accounts receivable efficiency. Fluctuating sales volumes can affect DSO, with any increase in sales lowering the DSO value.
Delinquent Days Sales Outstanding (DDSO) is a good alternative for credit collection assessment or for use alongside DSO. Like any metric measuring a company’s performance, DSO should not be considered alone, but rather should be used with other metrics.
Days Sales Outstanding FAQs
Here are the answers to the most commonly asked questions about days sales outstanding.
How Do You Calculate DSO?
Divide the total number of accounts receivable during a given period by the total dollar value of credit sales during the same period, then multiply the result by the number of days in the period being measured.
What Is a Good DSO Ratio?
A good or bad DSO ratio may vary according to the type of business and industry that the company operates in. That said, a number under 45 is considered to be good for most businesses. It suggests that the company's cash is flowing in at a reasonably efficient rate, ready to be used to generate new business.
How Do You Calculate DSO for 3 Months?
During the last three months of the year, Company A made a total of $1.500,000 in credit sales and had $1.050,000 in accounts receivable. The time period covers 92 days. Company A’s DSO for that period calculated as follows:
- 1,050,000 divided by 1,500,000 equals 0.7.
- 0.7 multiplied by 92 equals 64.4.
The DSO for this business in this period is 64.4.
Why Is DSO Important?
A high DSO number can indicate that the cash flow of the business is not ideal. It varies by business, but a number below 45 is considered good.
It's best to track the number over time. If the number is climbing, there may be something wrong in the collections department. Or, the company may be selling to customers with less than optimal credit. In any case, the company's cash flow is at risk.
The debt collections experts at Atradius suggest that tracking DSO over time also creates an incentive for the payments department to stay on top of unpaid invoices.
Needless to say, a small business can use its days sales outstanding number to identify and flag customers that are weighing it down by not paying promptly.
The Bottom Line
In many businesses, the days sales outstanding number can be a valuable indicator of the efficiency of the business and the quality of its cash flow. If the number gets too high, it could even disrupt the normal operations of the business, causing its own outstanding payments to be delayed.
In any case, cash delayed is cash lost to your business.