Days Sales Outstanding (DSO) and how to halve it

Days Sales Outstanding (DSO) and how to halve it

DSO, or Days Sales Outstanding, is the average number of days it takes for a company to collect cash payment from a credit sale. When a company sells on credit, it allows its customers to pay in cash at a later date. The average time to pay for a given period is the days sales outstanding.

The Days Sales Outstanding impacts the cash flow. For example, suppose a company takes a long time to convert its accounts receivable to cash. In that case, it will have a negative effect on the cash flow. Businesses that are focused on cash flow will strive to reduce DSO. A lower DSO means cash returns to the business more quickly.

Key points

  • Days Sales Outstanding is standard accounts receivable term often referred to as DSO.
  • DSO is the average number of days for a business to convert a credit sale to cash in the bank.
  • The days sales outstanding formula is (Average Account Receivable / Total Credit Sales) x Number of days.
  • You can lower DSO to achieve better cash inflow with strict credit control and a disciplined accounts receivable process.

What is the DSO formula?

The days sales outstanding formula is easy to calculate. It’s a measure of how quickly cash was recovered from outstanding sales invoices. While sales revenue may be a combination of cash and credit sales, only credit sales (accounts receivable) are considered in the DSO formula. That’s because cash sales are not counted as outstanding. DSO is typically measured month by month.

DSO = (Average Account Receivable / Total Credit Sales) x Number of days

You can see that if a business retains a high proportion in accounts receivable at the end of one month, its DSO will be high. It has not converted its credit sales into cash quickly, and that money is not available to run the business.

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A days sales outstanding example

Here’s how we arrive at a DSO calculation of 40 days for ABC Wholesale Company:

  1. We decide to calculate the DSO for the month of June, which has 30 days.
  2. On 1 June there was $105,000 in accounts receivable.
  3. On 30 June there was $95,000,00 in accounts receivable.
  4. We calculate the average value in accounts receivable for June was $100,000 (the average of $105,000 and $95,000).
  5. In June, ABC Wholesale Company recorded $75,000 in total credit sales.
  6. DSO = (100,000 / 75,000) x 30 days = 40 days

ABC Wholesale Company takes 40 days on average to collect a credit sale. 

Even without the calculation, we can quickly understand that ABC Wholesale Company is accruing more debt in relation to its monthly credit sales.

Imagine ABC Wholesale Company’s cash position if it halved its DSO to 20 days?

How to halve days sales outstanding

To halve its calculation of DSO to 20 days, ABC Wholesale Company can affect change upon two variables in the formula. Most simply, it could:

  1. Halve the average accounts receivable, or
  2.  
  3. Double the total credit sales.

Let’s see what happens when the business halves its average accounts receivable by collecting twice as much:

DSO = (50,000 /75,000) x 30 days = 20 days

Or, ABC Wholesale Company could also halve its DSO if it doubled its credit sales:

DSO = (100,000/150,000) x 30 days = 20 days

It’s always great to double sales, but that doesn’t automatically equate to improving the accounts receivable department’s collection efficiency. And collecting payments more quickly is the ultimate goal of lowering DSO.

The good news is that halving accounts receivable is achievable with strict credit controls and a disciplined accounts receivable process.

What is a high DSO?

‘High’ and ‘low’ days sales outstanding ratios are best considered in a broader context:

  • Industry: Some industries are much slower to pay than others.
  •  
  • Trends: Seasonal businesses experience highs and lows in their collections and sales, so compare DSO over comparable periods to determine acceptable highs and lows.
  •  
  • Business size: A DSO of 60 days may be ‘good’ for a large business but crippling to cash flow for a small business.
  •  
  • DSO can mask a bigger picture. We cover more considerations in our blog post on accounts receivable turnover ratio.
  •  

Why does a low DSO matter?

DSO is one metric of a company’s liquidity: how much access it has to cash to operate day-to-day. Small to medium-sized businesses rely on cash to pay their people, re-stock, and upgrade their systems. Slashing the days sales outstanding means the cash conversion cycle is much faster. With a lower DSO, there is more cash returning to the business each month, and that cash is available to fund business operations.

Without good cash recovery, it is harder to fund the activities that support sales.

What’s more, investors and creditors want to know that a business effectively manages its debts. Cash flow is a critical indicator of a business’s health and financial outlook.

How to improve DSO

The amount of time it takes to receive payment from customers (days sales outstanding) is not only determined by numbers! A significant influence on payment times is the quality of your debtor communications and relationships.

It’s a fact we prove time and again at ezyCollect: debtor relationships matter!

You can improve (lower) your days sales outstanding by improving your service offer to debtors. Payment times improve once your accounts receivable process becomes easier for you and your debtors.

Here are five simple tips:

1. Predetermine the likelihood of each new debtor to pay on time BEFORE issuing them credit. This way, you are not exposing your business to known late payers and are instead extending credit to buyers who are likely to pay on schedule.

2. Digitize your invoicing and payment chasing. These are both necessary activities if you offer trade credit. So automate your accounts receivable tasks for efficiency and accuracy, and ensure those collection communications reach your customers on time, every time.

3. Use collection calls and SMS reminders to connect with debtors. When emails aren’t enough, you need to cut through the noise with a timely and effective collection call and an SMS payment reminder included in your communication workflow.

4. Offer your customers payment convenience. Pay later, pay with a credit card, pay online. This variety is what business customers want. If you’re not offering these payment methods, know that someone else is. Guess who gets paid first?

5. Show gratitude for paying. This simple act is so powerful and often underestimated. If you could be the company that say thanks to its customers–why wouldn’t you? You can even personalize and automate your thank you message to make sure you never miss an opportunity to reinforce positive payment behavior.

In summary:

An increasing DSO indicates that debtors are taking more time to pay their invoices. Prolonged and late payment times limit a company’s access to essential cash flow to survive and thrive. When DSO is reduced, and the cash conversion cycle speeds up, cashflow can improve.

A business can improve its credit risk management and collections efficiency to solve DSO issues.

ezyCollect is purpose-built to reduce Days Sales Outstanding