- Days sales outstanding
In accountancy, Days Sales Outstanding (also called Days Receivables) is a calculation used by a company to estimate their average collection period. A low number of days indicates that the company collects its outstanding receivables quickly. Typically, Days sales outstanding is calculated monthly. The days sales outstanding (DSO) figure is an index of the relationship between outstanding receivables and credit account sales achieved over a given period. The Days sales outstanding analysis provides general information about the number of days on average that customers take to pay invoices.
Days sales outstanding is considered an important tool in measuring liquidity. Days sales outstanding tends to increase as a company becomes less risk averse. Higher Days sales outstanding can also be an indication of poor follow up on delinquencies, or higher DSO might be the result of inadequate analysis of applicants for open account credit terms. An increase in DSO can result in cash flow problems, and may result in a decision to increase the creditor company's bad debt reserve.
Days Sales Outstanding, or DSO, is calculated as: Total Outstanding Receivables at the end of the period analyzed divided by Total Credit Sales for the period analyzed (typically 90 or 365 days), times the number of days in the period analyzed. That is,
- DSO = (Receivables/Sales) * Days in Period (can use average receivables as a more conservative estimate)
Days sales outstanding can vary from month to month, and over the course of a year with a company's seasonal business cycle. Of interest when analyzing the performance of a company is the trend in DSO. If DSO is getting longer, customers are taking longer to pay their bills, which may be a warning that customers are dissatisfied with the company's product or service, or that sales are being made to customers that are less credit-worthy, or that salespeople have to offer longer payment terms in order to generate sales. It could also mean that the company has an inefficient or overburdened credit and collections department. Many financial reports will state Receivables Turnover defined as Net Credit Account Sales / Trade Receivables; divide this value into the time period in Days to get DSO.
However, Days sales outstanding is not the most accurate indication of the efficiency of accounts receivable department. Changes in sales volume influence the outcome of the days sales outstanding calculation. For example, even if the overdue balance stays the same, an increase of sales can result in a lower DSO. A better way to measure the performance of credit and collection function is by looking at the total overdue balance in proportion of the total accounts receivable balance (total AR = Current + Overdue), which is sometimes calculated using the Days Delinquent Sales Outstanding (DDSO) formula.
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