What is Days Sales Outstanding, Formula, and How to Improve It?Reading Time: 4 minutes
While many small businesses offer credit sales, the growing concern is the days it takes to get payment. Days Sales Outstanding (DSO) puts a value on credit duration and helps small businesses know when things may take a downturn.
Deciding on whether you need to offer credit sales to customers depends on a couple of factors, including but not limited to the knowledge of the customer’s credit history, the nature of the business, the industry, and more.
That is discussed extensively in an article about the net 30 payment terms.
Let’s get into understanding what days sales outstanding means.
What is Days Sales Outstanding (DSO)?
DSO measures how long credit sales take to convert into cash or the average collection period for a company’s accounts receivables.
It is usually calculated monthly, quarterly or yearly and provides a company with its financial state over a study of DSO trends.
An up-trending DSO could mean your company offers a lot of credit sales, potentially leading to cash flow challenges. At the same time, a down-trending chart could tell cash payments come in early – a good accounts receivable turnover.
DSO helps with cash flow management.
How to calculate days sales outstanding
To find Days Sales Outstanding, you should divide the current accounts receivables balance by the total number of credit sales in an accounting period, then multiply the result by the Number of Days in the measured period.
DSO = ( Total accounts receivables / Net credit sales in a period ) x Number of days
The period used to measure DSO can be monthly, quarterly, or annually.
Example of DSO calculation
Let’s say an Apple Ice cream company reports a sales revenue of $500,000 for August 2022. $400,000 is from credit sales, while $100,000 is from cash sales. The accounts receivable balance as of the month-end closing is $300,000.
( $300,000 / $400,000 ) * 30 = 22.5 days.
It takes Apple Ice cream company an average of 22.5 days to receive payment.
What qualifies as high or low depends on the business type and the industry. Generally, a DSO below 45 is low.
Is a higher or lower Days Sales Outstanding better?
As mentioned earlier, having a higher DSO could mean that your company takes more extended periods to convert credit sales to cash.
While a DSO of 45 is considered good with small businesses, it may differ with companies depending on size and financial structure.
A company with a large capitalization may not view a DSO of 60 as a severe issue.
For small businesses, higher DSO results in a higher risk of cash flow problems. This could affect the ability to handle current liabilities such as salaries, utilities, and other operational expenses.
On the other hand, having a low DSO could mean that customers are paying on time or your company offers strict credit policies.
Low DSO indicates that a small business has the cash flow to handle day-to-day obligations.
How can I improve my DSO?
Applying the following methods can lower the DSO for small companies with a higher value than the generally accepted 45.
- Before offering credit to customers, do a credit background check
- If your business has an unable cash flow rhythm, consider asking for upfront deposits.
- Offer Incentives such as discounts for cash payments
- Offer discounts for early payment of credit sales
- Study the payment history of customers
- Sometimes, you need to let go of bad customers
Final thoughts on DSO
Not offering credit sales may lead to low sales and eventually affect a business’s revenue flow.
So, it is essential to note that while trying to reduce DSO, you should consider what works best for customer satisfaction and what competitors offer.
Check out net 30 payment terms for ways to offer credit sales and keep your DSO low.
Days Sales Outstanding Frequently Asked Questions (FAQs)
- What Is a Good DSO Ratio?
A DSO number under 45 is considered to be suitable for most businesses. It suggests a healthy cash flow that can settle daily operational expenses.
- Is Days Sales Outstanding the same as receivables days?
Days sales outstanding represents how long it takes a company to collect revenue for credit sales. Accounts receivable DSO is a daily average measurement that is often assessed annually.
- How does DSO affect cash flow?
Lower DSO indicates that a company has a high accounts receivable turnover with more cash in its account. As a result, cash flow is fluid.
- DSO vs DDSO
Delinquent DSO (DDSO), also known as the Average Days Delinquent, calculates the average time from the invoice due date to the paid date. DSO is the measure of how long it takes credit sales to convert into cash. It evaluates the entire accounts receivable portfolio.
- What does a high Days Sales Outstanding mean?
High DSO means a company could be offering a lot of credit sales to customers and taking a long time to convert credit to cash. This affects a company’s cash flow.