Glossary
Days Sales Outstanding (DSO)
Tags: Glossary
DSO, also known as the Collection Period (period average), is a financial indicator that shows both the age, in terms of days, of a company's accounts receivable and the average time it takes to turn the receivables into cash. It is compared to company and industry averages, as well as company selling terms (e.g., Net 30), for determination of acceptability by the company. DSO is calculated as follows: DSO = (Total Receivables / Total Credit Sales in the Period Analyzed) x Number of Days in the Period Analyzed. Note that only credit sales should be used; cash sales are excluded.
What is Days Sales Outstanding (DSO)?
Days Sales Outstanding (DSO), also known as the Collection Period, is a financial metric that provides valuable insights into a company's accounts receivable management. It not only indicates the age of a company's outstanding invoices but also measures the average time it takes for those invoices to be converted into cash.
DSO is a crucial indicator for businesses as it helps them assess the efficiency of their credit and collection processes. By analyzing DSO, companies can gain a better understanding of their cash flow and identify potential issues in their accounts receivable management.
To calculate DSO, you need two key pieces of information: the total amount of receivables and the total credit sales during a specific period. It is important to note that only credit sales should be considered, while cash sales are excluded from the calculation.
The formula for calculating DSO is as follows:
DSO = (Total Receivables / Total Credit Sales in the Period Analyzed) x Number of Days in the Period Analyzed
Let's break down the formula further. First, you divide the total amount of receivables by the total credit sales during the period you are analyzing. This gives you a ratio that represents the average number of days it takes for a sale to be converted into an account receivable.
Next, you multiply this ratio by the number of days in the period analyzed. This step helps you determine the average number of days it takes for the company to collect its outstanding invoices.
By comparing a company's DSO to industry averages and its own selling terms (such as Net 30), businesses can evaluate the acceptability of their collection period. If a company's DSO is significantly higher than industry benchmarks or its own selling terms, it may indicate that the company is facing challenges in collecting payments from customers.
A high DSO can have negative implications for a company's cash flow and overall financial health. It may suggest that the company is granting overly generous credit terms, experiencing difficulties in collecting payments, or facing issues with customer creditworthiness. On the other hand, a low DSO indicates that a company is efficiently managing its accounts receivable and converting sales into cash quickly.
To improve DSO, companies can implement various strategies. These may include tightening credit policies, offering incentives for early payment, conducting credit checks on customers, and establishing effective collection procedures.
In conclusion, Days Sales Outstanding (DSO) is a vital financial indicator that measures the age of a company's accounts receivable and the average time it takes to convert those receivables into cash. By calculating and analyzing DSO, businesses can gain valuable insights into their credit and collection processes, identify areas for improvement, and ensure healthy cash flow management.