Days Sales Outstanding, or DSO, is commonly used as a benchmark to the efficiency and effectiveness of the accounts receivable department. Especially when management reports are created, CFOs, CEOs and owners are looking towards this key metrics to decide whether the accounts receivable department is doing their job well. Unfortunately for the AR department, this key metric is extremely flawed and usually creates a bad reflection on what was actually collected.
Since the calculation for DSO typically includes the total amount sold and annual figures, this overlooks many factors the go into the accounts receivable department and affect how they collect. Below are a few examples of how DSO can be flawed.
The total amount of money collected is divided by the average sales per day. The average sales per day skews this calculation because it doesn’t take into account what types of new accounts these are. These could be a huge influx of customers that are offered poor receivables terms or discounted product. Additionally, the accounts receivable department is then rated on a calculation that includes a department they have no control over.
When comparing DSO from 6 months ago to the current DSO, this can make an accounts receivable department look like they aren’t doing a very good job, when, in reality, they simply don’t have as much to collect on. If a company is highly seasonal, there sales will be higher during one or two quarters of the year, then drop off for the rest of the year, making a DSO comparison look like there has been a massive change.
Take, for example, a company that supplies ski equipment to ski lodges. Their peak season will probably be from October to March. For the rest of the year, they probably aren’t making a ton of sales. This will make their quarterly comparisons look dramatically different simply because there is a huge increase in sales.
Using DSO as a key metric can be problematic and not truly reflect the effectiveness (or ineffectiveness) of your accounts receivable team. DSO should always be used in conjunction with other key metrics that will give a wide view of how well the accounts receivable department is doing.
In our next blog post in this series, we will highlight some other key metrics that will be helpful in measuring your accounts receivables team’s collection efforts.