Days Sales Outstanding

Days Sales Outstanding (DSO)

What is DSO?

Days Sales Outstanding (DSO) measures the average number of days a company takes to collect payment after making a credit sale. It’s a key indicator of receivables efficiency and short-term liquidity, and it forms part of the cash conversion cycle.

Why DSO matters

• Shows how quickly sales convert to cash, affecting a company’s ability to pay bills and reinvest.
• Acts as an early warning sign for collection problems or deteriorating customer credit.
• Helps manage working capital and evaluate the effectiveness of the collections process.

How to calculate DSO

DSO = (Accounts Receivable ÷ Total Credit Sales) × Number of Days in the Period

Step-by-step:
1. Use average accounts receivable for the period (or ending receivables if consistent).
2. Use total credit sales for the same period (exclude cash sales).
3. Multiply the ratio by the number of days in the period measured.

Example (3 months, 92 days):
– Credit sales = $1,500,000
– Accounts receivable = $1,050,000
– DSO = (1,050,000 ÷ 1,500,000) × 92 = 64.4 days

Interpreting DSO

• Low DSO: Faster collections, healthier cash flow, more cash available for operations.
• High DSO: Slower collections, potential cash flow strain, risk that customers are late or credit standards are lenient.
• Trends matter more than a single number: rising DSO requires investigation; seasonal patterns may be normal for some businesses.

Note: DSO excludes cash sales. If cash sales were included, the metric would be lower, so compare like-for-like.

What’s considered “good”?

There’s no universal benchmark—DSO varies by industry and business model. As a general rule, many businesses consider a DSO under about 45 days reasonable, but always benchmark against industry peers and historical performance.

Practical uses

• Monitor collections performance and efficiency of the credit department.
• Flag slow-paying customers and adjust credit terms accordingly.
• Inform cash flow forecasting and working-capital decisions.
• Evaluate the impact of sales strategies that extend payment terms.

Limitations and caveats

• Industry differences: DSO is most meaningful when comparing companies within the same industry and business model.
• Sales-volume effects: Rapid changes in sales can distort DSO (e.g., higher sales can lower DSO).
• Doesn’t show the aging profile of receivables — a single average can mask past-due balances.
• Should be used alongside other metrics (e.g., receivables aging, AR turnover, Delinquent DSO) for a fuller picture.

How to reduce DSO

• Tighten credit approval and set clearer payment terms.
• Offer discounts for early payment or impose penalties for late payments.
• Improve invoicing accuracy and speed; automate reminders and collections.
• Use credit checks and credit limits; consider factoring receivables when appropriate.

Bottom line

DSO is a concise measure of how quickly a company converts credit sales into cash. It’s a useful tool for monitoring cash flow and collections efficiency, but it must be interpreted in context—against industry norms, company history, and other receivables metrics—to drive the right operational decisions.