DSO or Days Sales Outstanding is one of the most commonly used metrics to assess accounts receivable quality and collection efficiency. It is calculated by dividing accounts receivable at the end of the period to be measured by total credit sales for the same period and multiplying the result by the number of days in the period.
Accounts Receivable X Number of Days
Total Credit Sales
For example, assume:
- AR: $300,000
- Total Credit Sales: $600,000
- Period 30 days
- $300,000 X 30 days = 15 DSO$600,000
If DSO is increasing it may be an indication of a slowdown in customer payments or poor collection performance. Conversely, a decrease in DSO may indicate accelerated cash flow and better collection results.
DSO Limitations
DSO has drawbacks which need to be taken into consideration when you are trying to understand what DSO results mean. Seasonal patterns in sales and large swings in sales caused by any number of business factors can result in DSO measurements that should not be taken at face value.
Consider the following example:
| M1 | M2 | M3 | M4 | M5 | M6 | M7 | M8 | M9 | |
|---|---|---|---|---|---|---|---|---|---|
| Total Credit Sales $ | 400 | 400 | 400 | 400 | 600 | 800 | 600 | 400 | 200 |
| AR Balance $ | 200 | 200 | 200 | 200 | 300 | 400 | 300 | 200 | 100 |
| Days in Period | 30 | 30 | 30 | 30 | 30 | 30 | 30 | 30 | 30 |
| DSO | 15 | 20 | 7.5 |
If you calculate DSO at the end of each quarter as in this example, you get three widely different results even though the collection efficiency has not changed on a monthly basis. DSO remains the same each month. What has changed is that on a quarterly basis sales spiked in the second quarter and fell sharply in the third quarter. In this example taking DSO at face value would lead to incorrect conclusions for the second and third quarter.
How to Calculate DSO
To avoid incorrect conclusions you should calculate and compare DSO results on a comparable basis year over year, i.e. month versus prior year month, and quarter versus prior year quarter.
Also give consideration to factors which may skew the results such as:
- Seasonal sales history
- Large swings in sales, up or down, which may result from promotions, gain or loss of a major account, etc.
It is always preferable to look at a number of AR metrics in addition to DSO when evaluating the quality of your AR and collection efficiency such as:
- Percentage of AR past due
- Days past due
These will provide a means of validation for the trend in DSO results and be leading indicators which can help you to avoid the cash trap that expanding DSO can lead to.
Monitoring and controlling DSO and other AR metrics is very difficult with manual AR and collections. Manual systems create bottlenecks which hamper your collection team’s efforts and make calculating changes in metrics on a real time basis impractical.
With the technology applications made possible by automated accounts receivables and collections you can avoid cash traps, increase cash flow and reduce the costs of financing and collections.
The key to successfully automating your accounts receivable and collections is to work with an experienced software partner.
Lockstep Collect is a market leader in cloud-based credit and collection platforms. Lockstep Collect can help you to implement the technology applications you need to reduce and control DSO.
If you would like to learn more about how you can benefit from automating collections and accounts receivable, please contact Lockstep Collect at www.lockstep.io.
