What is Days Sales Outstanding Calculation

What is days sales outstanding calculation?

Learning about the cash conversion cycle in finance brings about the question that, what is days sales outstanding calculation? However, before considering the calculation, let’s find out what this term is all about.

Days Sales Outstanding (DSO) is a measure of the average number of days for a company to collect its account receivables. This includes conversion of the credit sales to cash upon customer or debtor payments. This factor can be determined by dividing the total accounts receivable over a period by the net credit sales. The value obtained from the division is then multiplied by the number of days involved.

This value can be measured in different time frames, it can be analyzed quarterly, monthly, or annually. In this ratio, having a low ratio means that the time taken to retrieve the cash is few. Having a high ratio, on the other hand, represents a longer period for cash retrieval.  It should be noted that a high value could be dangerous to a company’s working capital in the long run.

A company can obtain a low DSO by having a stable, effective credit policy, and methods for retrieving the payments. However, the low DSO can be because of a threatening effect from the company. Although this will help with quick payments, clients may be lost to competitors. Nevertheless, low days sales outstanding value can mean that the customers are quick in payment.

Key Facts

Here are some facts that you should pay close attention to about a firm’s days sales outstanding (DSO).

• A low DSO can be proof that the customers pay quickly and on time. However, this could be due to a stable financial state of the customers, an effective credit policy, or threats.
• A high DSO may not affect companies with a large capital early. However, for a company with low capital and assets, a high DSO can be very dangerous in the long run.
• Days sales outstanding calculation is also known as the average collection period. That is, it represents the time taken to recover payment for service provided to clients.

How to calculate the days sales outstanding?

It is important to a business owner to know the days sales outstanding calculation. It is quite simple and easy to know as it is one of the methods for determining a company’s cash conversion cycle.

Mathematically, the DSO is calculated through a simple formula as represented below:

DSO= Accounts receivable/Total credit Sales Number of days

This represents the expression that the DSO is equal to the division of the account receivable by the total credit sales. The product of this division is further multiplied by the number of days within the time frame being calculated.

Generally, it is agreed that a DSO value below 45 is low, although this can vary. Not to forget, a low DSO value is the best as it proves that customers pay off their credits quickly. When calculating the DSO value, the cash sales value is not included. 

It is advisable to deduct the value of the cash sales from the net sales value to calculate the total credit sales. The total credit sales are services that are provided on credit without cash payment.

Why is the firm’s days sales outstanding importance?

Knowing the days sales outstanding is very important as it helps to measure the liquidity of a firm’s assets. Nothing competes with the importance of a stable working capital in businesses. To small businesses, having a low DSO, which shows high returns is beneficial for growth and re-investment.

Hence, receiving returns from customers early helps to keep the business straight and ready. It also makes a company appealing to investors and encourages stakeholders to continue their support.

Knowing the days sales outstanding of a business can help to decide what risks and steps to take in business. In certain stages, a business needs to expand by obtaining more assets and manpower. However, having a high DSO will restrain capital and limit growth, and vice versa. The liquidity of a company, which is how well their assets can be converted to cash is also determined by this value.

DSO Application

Finding out the DSO of a company is very important as you may have observed if you followed through. However, importance is not always the same as the application. Therefore, here is a concise explanation of areas in a business where the DSO value is applicable.

It can be used to measure the number of sales a company has made over a time frame.it is also useful for determining how quickly payments are received from customers. DSO is useful to analyze the effectiveness of a company’s credit policy and the credit collection department. Do you need to determine if your customers are satisfied with your service? DSO can give a hint at that and make you aware of whether your customers are worthy of receiving credit sales.

Checking through a company’s DSO trend can give a very good idea of the cash flow and financial benchmarks of the company. An increasing DSO value could mean that customers have more expenses to cover or are not satisfied with the services.

Also, a high DSO value could represent negligence on the part of the company. This may be by providing credits for customers with a low credit score or offering longer payment terms.

Conclusion

What is days sales outstanding calculation? For most business owners, this might not mean much. However, it is a factor that is very important when monitoring the cash conversion cycle in business. It measures how long it takes for customers to make payments for the services they received on credit. 

The calculation is essential for several purposes, and one of these is the use to determine the financial status of a company. Also, it is used to measure the efficiency of some departments in the company.

However, having a low score is very important but should not be at the risk of losing customers. For companies with large assets, having a high DSO may not influence their company for a while. However, smaller companies tend to get affected as the cash flow usually maintains the business.