Days Sales Outstanding (DSO)
The days’ sales outstanding or days’ sales in accounts receivable is a ratio that basically tells you about the average number of days a company takes to collect its accounts receivable during a specific accounting period. In other words, it indicates how well an entity is collecting payments from its clients / customers. The days’ sales in accounts receivable or days’ sales outstanding can be calculated by using the following formula:
Days’ Sales in Accounts Receivable = (Accounts Receivable/ Credit Sales) x Number of Days in the Period
In the aforementioned formula, the receivable is divided by the sales made on credit during a specific, and then multiplied by the number of days in that specific period. The result is the days sales average, which provides insight into how an entity generates cash flow.
Days’ sales in accounts receivable is an important component of the cash conversion cycle and is often referred to as average collection period.
As cash is highly important for a business with regards to managing its day to day operations, it is in a corporation’s best interest to collect cash from its customers to which it had earlier delivered goods/ services on credit.
Days’ sales in accounts receivable can be used to indicate the total value of sales a corporation has made during the course of a specific accounting period. This can also be used to indicate as to how quickly customers are paying, if the company is maintaining customer satisfaction, if credit is being provided to customers that are not creditworthy or if the corporation’s collections department is working well.
A high days’ sales in accounts receivable number shows that a corporation is providing goods/ services to customers on credit and it is taking longer for the company to collect cash from customers to which it has sold products/ services on credit. This may lead to the company facing cash flow problems due to the long time duration between the time sales are made on credit and the time the corporation receives payment from its customers. A low days’ sales in accounts receivable figure means that it takes fewer days for a company to collect cash from its credit customers. In effect, the ability to calculate the average number of days a company takes to collect payment from its credit customers can in some cases help a lot in providing meaningful information about the nature of the corporation’s cash flow.
Generally, a days’ sales in accounts receivable below 45 days is considered to be low. However, what qualifies as a high or low days’ sales outstanding may often vary depending on the nature, type and structure of the business as well as the industry in which it operates.