Why You Should Know Your DSO
DSO, or Days Sates Outstanding, isa performance benchmark for accounts receivable. The DSO of a company's receivables reveals what your company can expect in the near and long term future with your cash flow. The turnaround speed, in days, of your company's receivables is a thermometer for the health of your AR department and credit policies. It is super easy to calculate your DSO.
DSO Calculation
DSO is the average number of days it takes your company to collect payment after a credit sales have been made. DSO is usually calculated by month, quarterly and annually for historical comparison.
The DSO calculation formula is simple: Take the amount of accounts receivable extended during a given time period in days. Then divide the total value of credit sales extended during the same period of time. Then multiply the result by the number of days in the same period. The total is your average number in days, or days sales outstanding.
($500,000 / $800,000) x 31 = .625 x 31 = 19.37 Days
In the example above a company has $500,000 dollars in accounts receivable over 31 days. The company made $800,000 in credit sales over 31 days. Dividing $500,000 by $800,000 equals .625. Multiply the .625 by 31 and the total is 19.37 days outstanding.
What Does a DSO Number Mean?
In some industries 19 days outstanding would be incredible and a sign that your accounts receivable is running smoothly on all cylinders. However, in other industries 19 days would be considered terrible.
For example: The wholesale produce industry usually has 7 day terms for payment so 19 days is not that good. Most industries have 30 day terms and 19 days outstanding is excellent. The only way to figure out how your days outstanding compares to other companies in your industry, is to do a bit of research. Industry associations can be a valuable source of industry specific information.
Commercial DSO is generally lower than consumer DSO. With consumer accounts a 45 DSO is usually acceptable. With commercial accounts (B2B), it really depends on the industry, goods and services being sold.
A DSO may indicate credit granting policies are too loose or too tight. A low DSO may indicate credit policies are too tight and the company is probably losing sales. In many instances when a credit manager boasts they never have any accounts go bad, you are talking to someone who is choking the life out their sales department.
A huge spike in Your DSO is usually an indicator of one of two things. Customers in your industry may be experiencing a significant downturn in business. Or, you have one or two large receivables that are distorting the numbers. In this case calculate a DSO with the large receivables and a DSO without.
A high DSO may indicate you have a collection process problem. Are statements and invoices going out when they should? Is proper follow-up being made with tardy customers? Are you holding on to accounts too long before placing for collection? Do your people need training? These are just a few of the questions you may want to ask yourself if you suspect your problem is with the collection process.
The list of what a high or low DSO could mean is endless. Every company and industry is different in its own way. Different industries have different payment terms. There is no one-size-fits-all method to interpret DSO.
Do You Know Your DSO?
DSO is old hat for many people and for good reason. It is a simple benchmark for what is going on with your cash flow. Over a period of time you will see seasonal DSO patterns, so you don't freak out when your receivables are a touch higher than normal at a certain time of the year. The best thing about DSO is one simple number tells you a LOT.
If you suspect you may have a problem in your collection related credit process please keep IRS, or In-House Receivable Services, in mind. We have been helping small, medium and large companies collect their receivables and streamline their credit operations for over 20 Years.
