Days Sales Outstanding: Definition, Importance, and Calculation

It is calculated by dividing the average accounts receivable balance by the average daily sales. A lower ACP indicates faster collections and better cash flow management. DSO is calculated by dividing the total accounts receivable by the average daily sales over a given period and multiplying it by the number of days in that period.

• Days Sales Outstanding (DSO) is a crucial financial metric for accounts receivable that tells us how long, on average, it takes a company to collect payments from its sales on credit.
• It is calculated by dividing the total amount collected during a period by the total amount of receivables at the beginning of that period, then multiplying by 100 to express it as a percentage.
• To get the most accurate results, it’s best to measure your DSO periodically instead of basing changes on individual DSO results.
• Invoicera offers recurring billing and customizable payment reminders, streamlining the entire billing and collection process.
• DSO may vary consistently on a monthly basis, particularly if the company’s product is seasonal.
• Companies in the technology, automobile, and furniture sectors can afford to hold on to their inventories for long, but those in the business of perishable or fast-moving consumer goods (FMCG) cannot.

Understanding Days Sales Outstanding

Adam Hayes, Ph.D., CFA, is a financial writer with 15+ years Wall Street experience as a derivatives trader. Besides his extensive derivative trading expertise, Adam is an expert in economics and behavioral finance. Adam received his master’s in economics from The New School for Social Research and his Ph.D. from the University of Wisconsin-Madison in sociology. He is a CFA charterholder as well as holding FINRA Series 7, 55 & 63 licenses. He currently researches and teaches economic sociology and the social studies of finance at the Hebrew University in Jerusalem.

DSO = (Average Accounts Receivable / Total Credit Sales) * Number of Days

Hence, in this case, the company takes, on average, about 18 days to convert credit sales into cash receipts. Join BC Krishna, CEO of Centime, to explore how AR automation can transform your collections process, improve cash management, and delight your customers. CEI measures how effective your collections efforts are in recovering outstanding receivables.

Limitations of DSO

• A lower DSO reflects faster cash collection, while a higher DSO may indicate inefficiencies.
• One must also note that a high DSI value may be preferred at times depending on the market dynamics.
• If sales decreases in isolation DSO will increase indicating that may run into cash flow problems in future when the sales dip flows through the collection cycle.
• This may indicate problems with your collections process, overly generous credit terms, or customers experiencing financial difficulties.
• Offering a wide range of payment options can help eliminate this common barrier to getting paid on time.
• Even if some profit is lost due to the factoring costs, liquidity is maintained and the days sales outstanding are shortened.

Investing in accounts receivable software like InvoiceSherpa can transform your collections process. Our platform automates invoicing, sends reminders, and provides real-time tracking of overdue accounts, making it easier to manage receivables and improve your DSO. A higher ratio indicates a company with poor collection procedures and customers who are unable or unwilling to pay for their purchases. Companies with high days sales ratios are unable to convert sales into cash as quickly as firms with lower ratios. Invoicera, a comprehensive invoicing and billing software, offers a streamlined way to effortlessly calculate Days Sales Outstanding (DSO). By harnessing its features, you can gain valuable insights into your business’s financial health and customer payment trends.

Why DSO Matters for Your Business

This can stem from poor follow-up on overdue invoices, ineffective invoicing systems, or inadequate credit control procedures. It may also indicate that the accounts receivable team is understaffed or lacking resources, leading to definition days sales outstanding.com slower processing of invoices and collections. Since DSO is an industry-standard metric, it allows businesses to benchmark their performance against their competitors. This comparison helps in understanding competitive positioning and identifying areas for improvement.

Having cash on hand also enables you to take advantage of early payment discounts from suppliers and reduces the need for external financing, which can come with high-interest costs. A good DSO varies by industry, but generally, a lower DSO indicates better performance. Company Xing had Gross Credit Sales of $500,000 in a year, Sales Returns of $50,000, and Accounts Receivables of $90,000. It calculated the DSO to check how balanced its cash conversion cycle is. For example, the average DSO for discount stores, like Dollar General, Burlington Stores, etc., is approximately 4 days.

It is also possible that the company may be retaining high inventory levels in order to achieve high order fulfillment rates, such as in anticipation of bumper sales during an upcoming holiday season. To manufacture a salable product, a company needs raw material and other resources which form the inventory and come at a cost. Additionally, there is a cost linked to the manufacturing of the salable product using the inventory.

If the DSO calculated is low, businesses frequently receive cash for their credit sales, which signifies their efficient cash conversion cycle. On the other hand, if the DSO is high, it implies the infrequent flow of cash for businesses, affecting their performance financially in the long run. But your ideal days-sales-outstanding ratio depends on your industry and type of business. According to the Credit Research Foundation, the average days sales outstanding for the third quarter of 2024 for domestic trade receivables was 36.8 days. Analyzing changes in DSO allows companies to assess customer credit risk more effectively.

An increasing trend might signal difficulties faced by clients in making timely payments or problems within your own collections process. 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.

In the next section, we’ll cover how to interpret these results and what they reveal about your financial health. Implement a system that promptly sends invoices when the service is provided or the product is delivered. Automating reminders for pending payments can significantly reduce delays. For instance, if your accounts receivable is $10,000, and your average daily credit sales are $1,000, your simple DSO would be ten days.