Days Sales Outstanding (DSO) is the average number of days it takes a company to collect payment on a sale. Generally, DSO is determined monthly, quarterly, or annually.

DSO is part of the cash conversion cycle and is sometimes referred to as accounts receivable days or average collection period.

Key points to keep in mind about DSO

• DSO is the average number of days it takes a company to collect payment on a sale.

• A high DSO implies that the company has problems collecting payments, which causes cash flow issues.

• A low DSO suggests the company is collecting payments quickly, which is beneficial to keep investing in the business efficiently.

• Generally, a DSO of less than 45 days is considered low.

• Companies with a high DSO can opt for a safe invoice factoring option to get cash quickly.

Understanding Days Sales Outstanding (DSO)

Since a company requires cash to operate, it would prefer to collect its existing accounts receivable as soon as possible. While companies may have some confidence that they’ll receive payment for their accounts receivable, inflation means any delay in payments represents a loss of value in the money. Of course, “as soon as possible” depends on the sector in which the business operates.

How is DSO calculated?

Divide the total number of accounts receivable during a given period by the total value of credit sales in the same period, then multiply the result by the number of days in the period being measured.

$$ DSO = ( Accounts.Receivable / Total.Credit.Sales ) × (Number.of.Days) $$

By quickly turning sales into cash, a company has the opportunity to use that money again to capitalize itself and achieve greater financial stability.

What do the numbers tell us?

A high DSO shows that a company sells its product on credit and takes a long time to collect the money, which can lead to cash flow problems. A low DSO value means the company takes fewer days to collect its accounts receivable, allowing it to quickly receive the money it needs to generate new business.

Determining the average duration of outstanding balances in a company’s accounts receivable can reveal a lot about the nature of the company’s cash flow.

It’s important to remember that the formula for calculating DSO only takes credit sales into account. If cash sales were considered with a DSO of 0, they would reduce the DSO, and companies with a high proportion of cash sales would have lower DSOs than those with a high proportion of credit sales.

Applications of Days Sales Outstanding

DSO can be analyzed in many ways. It suggests how efficient the company’s collections department is and to what extent the company is maintaining customer satisfaction. It also helps identify customers who are not creditworthy.

Analyzing the DSO value of a company for a single period can be a good benchmark to quickly assess a company’s cash flow. However, DSO trends over time are much more useful and can act as an early warning sign of problems.

Good and Bad DSO Numbers

If a company’s DSO is increasing, it’s a warning sign that something is wrong. Customer satisfaction could be declining or salespeople could be offering longer payment terms to drive sales. Maybe the company is allowing customers with bad credit to buy on credit.

A drastic increase in DSO can cause serious cash flow problems for a company. If a company’s ability to make its own payments on time is affected, it could be forced to make drastic changes.

Generally, when analyzing a company’s cash flow, it’s useful to track the DSO trend over time to determine whether it’s rising, falling, or whether there are patterns in its cash flow history.

DSO can vary consistently on a monthly basis, particularly if the company’s product is seasonal. If a company has a volatile DSO, this can be a cause for concern, but if its DSO regularly drops during a particular season each year, there might be no reason for alarm.

Limitations of Days Sales Outstanding

As a metric for evaluating business efficiency, DSO has a limitation that any analyst should consider.

When using DSO to compare the cash flows of several companies, you must compare companies within the same industry, with similar business models and revenue figures. If you try to compare companies in different industries and of different sizes, the results can be misleading because they often have different benchmarks and DSO targets.

When DSO is not as relevant

DSO isn’t particularly useful for comparing companies with significant differences in the proportion of sales made on credit. The DSO of a company with a low proportion of credit sales doesn’t say much about that company’s cash flow. Comparing such companies with those that have a high proportion of credit sales doesn’t offer much information either.

Conclusion

In conclusion, in many companies, the number of DSO days can be a valuable indicator of business efficiency and the quality of its cash flow. If the number is too high, it could even disrupt the normal operations of the business, causing delays in its own outstanding payments. KredFeed is a fast and simple alternative with which you can collect your outstanding sales invoices in advance and significantly improve your company’s cash flow. Learn more at: www.kredfeed.com/#beneficios