Well, here we are again – the end of another year. While you review your balance sheet all year, December is when you scrutinize it upside down and inside out. What did you do right throughout the year? What can be tightened up? Days Sales Outstanding – or “DSO” – is one of the metrics that you should be paying close attention to. Once you calculate your DSO you’ll need to make a few comparisons to determine your department’s effectiveness. You’ll need to compare your DSO to your company’s Best Possible DSO and to Industry DSO Benchmarks. While DSO is not an actual line item on your balance sheet, the the calculation is simple.
Calculate Days Sales Outstanding
- Select a time period and determine the number of days in that period,
- Take your total Accounts Receivable for that period and divide it by the total credit sales in that same period. Multiply the result by the number of days in that period.
[Accounts Receivable / Credit Sales] x Days = DSO
“Best Possible” Days Sales Outstanding
[Current Receivables / Total Credit Sales] x Days = BPDSO
Since DSO indicates the amount of time it takes for you to convert your sales to cash, your goal is the lowest possible number. The Best Possible DSO is the same as your terms of sale; that is if everyone paid you on the day due. While that is not realistic, the higher the number, the more interest free loans you’re giving to your customers and that translates into less available cash to fund your business, and its growth. After comparing your DSO to your BPDSO, you also need to compare it to your industry peers and to get that information you need to be part of an Industry Trade Group.
Looking at your DSO once a year may be an eye opener but looking at DSO monthly will provide you with trending and historical information that will be very valuable to you.
A DSO that is trending higher could be an indicator of the efficiency [or lack thereof] of your collections department. Is it staffed properly? Are your people properly trained to speak with your customers about outstanding invoices? Is it time for some outside help by a Receivables Management firm? A good firm can assist you with 1st party soft calls as well as traditional 3rd party collection expertise.
Consider the following scenario: If your A/R is $3,000,000 with Net 30 terms, if you cut your DSO from 50 to 40 days (20%), you are picking up $600,000 cash. This means you’ll have to get your customers to pay you an average of 10 days late vs 20 days late, hardly an insurmountable task if you work at it.
Many if not most companies use bank financing to for working capital needs. In the above scenario, cutting your DSO by 20% with a proactive and consistent collection campaign reduces the need for $600,000 of borrowing, and also cuts bad debts (since fewer accounts age out for a long time).