Days Sales Outstanding

What Is Days Sales Outstanding?

Days Sales Outstanding (DSO) is a financial metric that calculates the average number of days it takes a business to collect payment from customers after a credit sale. It reflects the efficiency of a company’s accounts receivable and collections processes. A lower DSO indicates faster payment collection, improving cash flow, while a higher DSO suggests delays that could strain liquidity.

Why DSO Matters

Cash Flow Management: DSO directly impacts a company’s working capital. Faster collections ensure funds are available for operations, investments, or debt repayment.
Credit Policy Effectiveness: A rising DSO may signal overly lenient credit terms or poor customer creditworthiness.
Financial Health: Investors and lenders view a low, stable DSO as a sign of strong operational efficiency.
Benchmarking: Comparing DSO to industry peers helps identify inefficiencies. For example, retail businesses often have low DSO (near 0 days), while manufacturing or construction may aim for 45–60 days.

How to Calculate DSO

The standard formula for DSO is:
DSO = (Average Accounts Receivable / Total Credit Sales) × Number of Days

Steps:

Determine the time period (e.g., monthly, quarterly, annually).
Calculate average accounts receivable: (Beginning AR + Ending AR) / 2.
Identify total credit sales during the period (exclude cash sales).
Plug values into the formula.

Example:
A company has $50,000 average AR, $280,000 quarterly credit sales, and uses a 90-day period:
DSO = ($50,000 / $280,000) × 90 = 16 days.

High vs. Low DSO

High DSO: Indicates slow collections, potentially due to inefficient invoicing, weak credit policies, or customer financial distress. A DSO exceeding payment terms by 25% warrants investigation.
Low DSO: Suggests efficient collections but may signal overly strict credit terms that deter customers. Aim for a DSO aligned with industry norms (often 30–45 days).

Key Factors Affecting DSO

Industry Norms: Sectors like SaaS may have longer DSO than retail.
Payment Terms: Net-30 invoices typically target a 30-day DSO.
Seasonality: Holiday sales might temporarily spike DSO.
Customer Behavior: Economic downturns can delay payments.

Best Practices to Improve DSO

Streamline Invoicing: Automate invoice generation and delivery to reduce delays.
Offer Incentives: Provide early-payment discounts (e.g., 2% off for payments within 10 days).
Diversify Payment Options: Enable online payments, bank transfers, or auto-charging for recurring services.
Enhance Collections: Use automated reminders, aging reports, and escalation protocols for overdue invoices.
Review Credit Policies: Conduct customer credit checks and adjust terms based on payment history.
Monitor Trends: Track DSO monthly and compare to industry benchmarks.

Limitations of DSO

Seasonal Fluctuations: DSO may skew during peak sales periods.
Industry Variability: Cross-industry comparisons are unreliable.
Business Model Differences: Cash-heavy businesses (e.g., restaurants) may show artificially low DSO.
One-Time Events: Large, irregular sales can distort averages.

Frequently Asked Questions

What is a good DSO?
A "good" DSO varies by industry. Generally, 30–45 days is healthy, but compare to peers for context.

How can I reduce DSO without harming customer relationships?
Offer early-payment discounts, simplify payment methods, and communicate transparently about terms.

Does DSO apply to cash sales?
No. DSO only measures credit sales, as cash sales have no collection delay.

How often should DSO be calculated?
Monthly tracking is ideal to spot trends and address issues promptly.