Days Sales Uncollected is an important ratio for the investors and creditors of the company which helps in measuring the days within which the company will actually receive the cash for its sales and it is calculated by dividing average accounts receivable by the net sales and then multiplying the resultant with a total number of days in a year.
What is Days Sales Uncollected?
The Days’ Sales Uncollected, also known as the average collection period, is one of the liquidity ratios that is measured to estimate the number of days before receivables will be collected. The ratio is used by creditors and investors widely to determine the short-term liquidity of the company. In terms of individual, the days’ sales uncollected ratio formula measures how long it will take for the customers to pay their credit card balances.
Components of Days Sales Uncollected
#1 – Accounts Receivable
Accounts ReceivableAccounts ReceivableAccounts receivables refer to the amount due on the customers for the credit sales of the products or services made by the company to them. It appears as a current asset in the corporate balance sheet. is the proceeds of payments due to the company for its credit salesCredit SalesCredit Sales is a transaction type in which the customers/buyers are allowed to pay up for the bought item later on instead of paying at the exact time of purchase. It gives them the required time to collect money & make the payment. to its customers. When a company extends credit to the customer, it provides a time period to the customers for payment. The sales are realized when the invoice is generated.
#2 – Net SalesNet SalesNet sales is the revenue earned by a company from the sale of its goods or services, and it is calculated by deducting returns, allowances, and other discounts from the company's gross sales.
Net sales are the company’s gross sales after returns, discounts, and allowances. Revenues reported on the income statement often represent net sales.
Days Sales Uncollected Formula
The days’ sales uncollected ratio divides accounts receivable by net sales and multiplies it by 365. It can be expressed as:
The result is expressed in days.
- Data of Accounts receivable can be picked up from the balance sheetThe Balance SheetA balance sheet is one of the financial statements of a company that presents the shareholders' equity, liabilities, and assets of the company at a specific point in time. It is based on the accounting equation that states that the sum of the total liabilities and the owner's capital equals the total assets of the company..
- Credit sales have to be provided by the company. They are rarely reported in the separate head in the income statement.
- Cash can be used for different operational activitiesOperational ActivitiesOperating activities generate the majority of the company's cash flows since they are directly linked to the company's core business activities such as sales, distribution, and production. if it is collected sooner. With lower days sales uncollected, liquidity and cash flows tend to increase. It also depicts that accounts receivables are not bad debtsBad DebtsBad Debts can be described as unforeseen loss incurred by a business organization on account of non-fulfillment of agreed terms and conditions on account of sale of goods or services or repayment of any loan or other obligation. but are good in nature.
- A higher ratio shows the non-suitable collection process. Also, customers are not able or unwilling to pay. Such companies face problems to convert sales into cash.
Days Sales Uncollected Examples
Below are the Examples of days sales uncollected as follows.
Suppose ABC Ltd. is a US-based Company. At the end of March 2018,
- Accounts Receivable=$400,000.
- Net Credit Sales=$3,600,000.
So, the days’ sales uncollected will be
Days’ Sales Uncollected Formula = Accounts Receivable/Net Sales * 365
= 40.56~ 41 days.
So, ABC Co. will require approximately 41 days to collect the receivables.
Suppose Doro’s Pine Boards is a UK based retailer that offers credit to customers. Doro sells inventory to customers as per the credit policy, wherein customers will pay within 30 days. Some customers pay promptly, but some make a delayed payment. The company’s financial statements Financial StatementsFinancial statements are written reports prepared by a company's management to present the company's financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels. have the following details:
- Accounts Receivable: £11,000
- Net Credit Sales:Net Credit Sales:Net credit sales is the revenue generated from goods or services sold on credit excluding the sales discount, sales allowance and sales return. It even amounts to the accounts receivables for a certain accounting period. £131,000
Days’ Sales Uncollected Formula = Accounts Receivable/Net Sales * 365
=30.65 days~ 31 days
The company takes 31 days to collect cash. So, it is a good ratio that it is similar to the company’s set standard.
Advantages of Days Sales Uncollected
- If a department store or any organization sells its goods and services to its customers or clients on credit, they are ultimately selling more products. So, they have large accounts receivable on their books, which is a good sign for their financial performance.
- For management, apart from liquidity, the ratio can be used to estimate the effectiveness of credit and collection activities.
- It can be used as a tool for peer creditors in case one creditor finds a customer or party not creditworthy to give products on a credit basis. It can work as a warning for others too.
- It can indicate if the company is maintaining customer satisfaction or if credit is being given to customers who are not creditworthy.
Disadvantages of Days Sales Uncollected
- A high ratio shows that the company is taking longer to collect money that may lead to cash flow problems.
- If a company’s payment of expenses is directly dependent on payments received from accounts receivable, a sharp rise in the ratio can disrupt this flow, and drastic changes can be required.
- If a company has a volatile Days Sales Uncollected ratio, this may be cause for concern, but if a company’s ratio dips during a particular season each year, there is no issue.
Limitations of Days Sales Uncollected
If we consider the efficiency of a business, days sales uncollected comes with a set of limitations that are important for any investor to notice:
- When companies are compared based on the ratio, it must be done in the same industry so that they can have similar business models and revenue. Companies of different sizes often have very different capital structures, which can influence calculations.
- The ratio is not useful in comparing companies with significant differences in the proportion of credit sales.
- The ratio is not a perfect indicator of a company’s accounts receivable efficiency, as it is dependent on volume and frequency of sales. Days Sales Uncollected must be used along with other metrics.
- It only accounts for credit sales. It ignores cash sales. If they were factored into the calculation, they would decrease the ratio.
- Generally, Days Sales Uncollected ratio as below 45 days is considered low. However, it depends on business type and structure. There is no ideal ratio.
- The unusually high figure depicts casual credit policy or inadequate collection process. It could be possible because of the slow economy where customers are not able to pay.
- Another point to consider is Seasonality. The business sales may vary from month to month. So, the receivables figures in the numerator may not be a true picture of a particular time period or the entire year.
- Also, consider the distribution. Some of the receivables could be overdue for a long, and this may impact the measurement. Notation can be useful in this regard.
We can conclude that Days Sales Uncollected is widely used for collections and credit management. It assists with cash flow planningCash Flow PlanningCash flow plans are those in which an insurance company assesses its income and expenses in order to maintain cash flows and also to keep cash flows above expenses. It can also refer to an individual's plan to ensure cash liquidity in such a way that they manage their expenses while maintaining a minimum balance.. It’s an indicator of the success of the collection department. However, it is largely affected by external factors like is the client’s business is powerful or what is the business condition as a whole. It is very important to keep a check on the ratio as it is an indicator of liquidity and solvency of the organizationSolvency Of The OrganizationSolvency of a company means its ability to meet the long term financial commitments, continue its operation in the foreseeable future and achieve long term growth. It indicates that the entity will conduct its business with ease..
This article has been a guide to what is Days Sales Uncollected. Here we discuss how to calculate days sales uncollected along with its formula and step by step examples. You may learn more about accounting from the following articles –