Days sales outstanding (DSO) is a measure of the average number of days that it takes a company to collect payment for a sale. DSO is often determined on a monthly, quarterly, or annual basis.
To compute DSO, divide the average accounts receivable during a given period by the total value of credit sales during the same period, and then multiply the result by the number of days in the period being measured.
Days sales outstanding is an element of the cash conversion cycle and may also be referred to as days receivables or average collection period.
Equation: DSO = (Accounts Receivable / Total Credit Sales) x Number of Days
A high DSO number shows that a company is selling its product to customers on credit and waiting a long time to collect the money. This can lead to cash flow problems. A low DSO value means that it takes a company fewer days to collect its accounts receivable. That company is promptly getting the money it needs to create new business.
It is important to remember that the formula for calculating DSO only accounts for credit sales. While cash sales may be considered to have a DSO of 0, they are not factored into DSO calculations. If they were factored into the calculation, they would decrease the DSO, and companies with a high proportion of cash sales would have lower DSOs than those with a high proportion of credit sales.
If a company’s DSO is increasing, it’s a warning sign that something is wrong. Customer satisfaction might be declining, or the salespeople may be offering longer terms of payment to drive increased sales. Perhaps the company may be allowing customers with poor credit to make purchases on credit.
A sharp increase in DSO can cause a company serious cash flow problems. If a company’s ability to make its own payments in a timely fashion is disrupted, it may be forced to make drastic changes.
Note: 37.3 is the average DSO for companies across various industries.
Configuration: Accounts Receivable account used is the account set up previously in System and GL Setup.
Source: Investopedia
