Days Sales Outstanding

Updated on May 9, 2024
Article byWallstreetmojo Team
Reviewed byDheeraj Vaidya, CFA, FRM

What Is Days Sales Outstanding (DSO)?

Days Sales Outstanding (DSO) refers to the average time a company or business takes to convert its credit sales into cash or collect the outstanding payments from customers. It is expressed in the number of days the credit sales providers take to retrieve their accounts receivables.

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Computing the DSO monthly, quarterly, or annually helps businesses understand how quickly they receive or collect cash for their credit sales. In addition, it enables businesses to keep the cash flows balanced, thereby saving them from running short of funds in the long run.

Key Takeaways

  • DSO is the average time expressed in the number of days businesses or companies take to retrieve their Accounts Receivables or collect cash for their credit sales.
  • While a low DSO implies a better market position of a company, a higher DSO indicates infrequent cash flows for a business.
  • The concept of Time Value of Money well defines and elaborates the Days Sales Outstanding meaning, signifying the importance of cash presently in hand.
  • Whether the DSO value is good or bad for a business will depend on the sector it operates in.

Understanding Days Sales Outstanding

Days Sales Outstanding determines the average number of days businesses take to get paid for the goods and services they sell on credit. DSO is one of the key performance indicators for any business as it helps them assess the cash flows over a period.

If the DSO calculated is low, businesses frequently receive cash for their credit sales, which signifies their efficient cash conversion cycle. On the other hand, if the DSO is high, it implies the infrequent flow of cash for businesses, affecting their performance financially in the long run.

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Days Sales Outstanding (DSO) Explained in Video

Interpretation

The DSO concept runs on the Time Value of Money (TVM) principle, advocating the importance of the business’s cash. Therefore, as the current value of money is more, the sooner it is received, the better it is.

However, assessing what DSO range is good or bad is crucial. A DSO high for one sector might be a low DSO for another. Thus, the good or bad value of DSO varies from one sector to another. For example, the average DSO for discount stores, like Dollar General, Burlington Stores, etc., is approximately 4 days. On the other hand, the same value is unexpectedly low for the oil and gas sector as its normal DSO ranges between 50 and 130 days.

Days Sales Outstanding Formula

The Days Sales Outstanding formula to calculate the average number of days companies take to collect their outstanding payments is:

DSO = (Accounts Receivables)/(Net Credit Sales/Revenue) * 365

Example With Calculation

Let us consider the following Days Sales Outstanding example to understand the concept better.

Company Xing had Gross Credit Sales of $500,000 in a year, Sales Returns of $50,000, and Accounts Receivables of $90,000. It calculated the DSO to check how balanced its cash conversion cycle is.

Here is how the Days Sales Outstanding calculation performs:

As the Gross Credit Sales and Sales Return are known, Company Xing computed its Net Credit Sales.

Net Credit Sales = Gross Credit Sales – Sales Return

                           =$500,000 –$50,000

                           =$450,000                                                                              

Now, the company used the Accounts Receivables information and Net Credit Sales figure as obtained to calculate the DSO.

Using the DSO formula:

DSO = (Accounts Receivables/Net Credit Sales/Revenue) * 365

         = (90,000/450,000) * 365

         = 73 days

Thus, the average number of days that Company Xing takes to recover cash for its credit sales or debts is 73 days.

Days Sales Outstanding vs Accounts Receivable Turnover

DSO and Accounts Receivable Turnover are two major key performance indicators for any business. While DSO is the term that defines the average number of days taken for firms or companies to get paid for their credit sales, A/R Turnover Ratio is the average number of times they receive the cash for their Accounts Receivables over a specific period.

DSO vsAccounts Receivable Turnover

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When the DSO is low for a business, it implies its good performance, while having a low A/R Turnover ratio indicates infrequent cash flow, which is not a good thing for any business from any sector/industry.

If a company’s period for recovering the payments of goods and services sold on credit is low, it suggests that the cash flow is frequent and the A/R Turnover ratio is up to the mark.

The formula to calculate A/R Turnover Ratio is:

A/R Turnover = (Net Credit Sales)/(Average Accounts Receivable)

Frequently Asked Questions (FAQs)

What is Days Sales Oustanding?

DSO refers to the average number of days businesses take to collect payments for the goods and services they sell to customers on credit. If the DSO value is low, it indicates that a business receives cash flows at regular intervals and on time. As a result, the business is said to have a good position in the market.

While if the case is otherwise and DSO is higher, signifying more days taken to collect cash for the credit sales indicates a hampered market reputation for the company/business. However, a high DSO for one could be a low DSO for the other sector and vice-versa.

How to find Days Sales Oustanding?

To find the DSO, the Accounts Receivable is divided by the Net Credit Sales, and the result obtained is multiplied by 365. Therefore, it is expressed as follows:

DSO = (Accounts Receivables)/(Net Credit Sales/Revenue) * 365

Where

Net Credit Sales = Gross Credit Sales – Sales Return

How to improve DSO?

The DSO value can be improved by ensuring the payments are received on time and as frequently as possible. It could be done by adopting a few measures, which include:
– Having strict payment terms
– Remaining updated about the current DSO status
– Being careful with credit sales
– Have stricter action plans for missed or delayed payments
– Try collecting cash upfront
– Keep a recurring payment option
– Introduce multiple payment options for customers

This article was the Days Sales Outstanding (DSO) meaning. Here we interpret Days Sales Outstanding Formula with example and complete calculation. You may also have a look at the below articles learn further –

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Comments

  1. Anika says

    Well awsm website.

    • Dheeraj Vaidya says

      Thanks for your kind words!