Days Sales Outstanding FormulaDefined with Formula & More

Written By:
Lisa Borga

What is Days Sales Outstanding?

Days Sales Outstanding (DSO) is a metric representing the average number of days it takes for a business to collect cash payments for sales made on credit.

This metric is often expressed on a yearly basis to allow for easy comparison.

DSO is computed by dividing the average balance of accounts receivable for the period being calculated by the value of the periods’ credit sales.

The resulting value is then multiplied by the days in the measurement period.

For companies offering sales on credit, DSO represents a critical facet of liquidity.

Because DSO represents the average length of time that it takes for a company to receive cash payment for sales, it is important for a business to be aware of this number when planning for future cash flow.

The Meaning of Days Sales Outstanding

Managing liquidity is a core component of business management.

Greater liquidity means more cash on hand that can be used in case of emergency expenses and reallocated for any purpose.

In addition to increasing liquidity, the time value of money makes a fast collection time doubly important.

Because cash can be invested and result in future gains, a longer collection time means that money is effectively being lost.

However, it is important to keep in mind that a typical collection time varies based on industry.

For many sales, manufacturing, and agricultural companies, the average collection time is relatively short; however, for the financial industry, payment periods are often relatively long.

Generally, smaller companies depend upon regular cash flow to a greater degree than large companies with diverse income streams.

The formula for days outstanding is:

DSO = (Accounts Receivable /Total Credit Sales) * Days in Period

Evaluating DSO Numbers

If a business has a high days sales outstanding, it indicates that the business is making sales on credit but taking a significant amount of time to collect payments.

Doing this can cause problems with cash flow.

A low DSO indicates that a business is not taking as long collect on its credit sales.

This allows the business to get the money that it can use to generate new sales.

This means calculating the average amount of time a business carries its outstanding balances in receivables is useful for learning a lot about a business’s cash flow.

When computing DSO, it is essential to include only credit sales, not cash sales.

Cash sales basically have a DSO of zero, but they aren’t included in the DSO calculation.

Including cash sales in the DSO calculation would reduce the DSO and cause businesses with a high percentage of cash sales to have a lower DSO than businesses with a high percentage of credit sales.

Analyzing DSO

There are several ways to analyze DSO.

This metric can show whether or not a business’s collection department is doing a good job as well as how satisfied the business’s customers are.

It can also be useful for determining which customers should continue to be offered credit.

Calculating a business’s DSO for one period is useful for conducting a quick assessment of its cash flow.

But, observing the business’s DSO over a longer period of time is more useful and can even serve to warn investors of trouble to come.

Increasing DSO Numbers

An increasing DSO is a sign that a business has a problem.

It could be a problem with customer satisfaction or possibly the result of giving longer payment times to improve sales.

It may even be the result of giving credit to customers with a poor credit history.

If a business’s DSO has suddenly increased, it could cause significant cash flow issues.

This situation may make it difficult for a business to meet its own expenses, thus requiring the business to make significant changes.

It’s best when considering a specific business’s cash flow to look at its DSO over a longer period of time to see if the DSO is increasing or decreasing or if there is any sort of a pattern.

For some businesses, DSO can vary monthly.

This is particularly true for businesses with a seasonal product.

So, if a business’s DSO fluctuates a lot, it may indicate a problem.

But, if it happens consistently at a particular time of the year, it may not be a problem.

DSO Example

An example of this would be a company that had $1,000,000 for its credit sales and $500,000 in its accounts receivable in November.

November has 30 days; therefore, the company would compute its DSO as follows.

$500,000/$1,000,000 = .50

.50 * 30 = 15

The DSO would be 15 days.

The company has a DSO of 15 days.

This means the company converts its receivables into cash in a short period of time on average.

Typically, a DSO of less than 45 days is thought to be low.

However, this may be different for different business structures or types.

Limits When Using DSO

There are some limits to the usefulness of DSO that investors should consider before using the metric.

If an investor wants to compare several businesses’ cash flows, these companies should be in the same industry and preferably have revenue numbers as well as business models that are similar.

This is important since a good DSO can vary for businesses of different sizes or from different industries.

When DSO May Not Be as Useful

There are situations in which the DSO may not be as useful, such as when two companies that have considerable differences in the percentage of sales that they make on credit are being compared.

In this case, the DSO for the company that only makes a small percentage of its sales on credit would not provide much information on the company’s cash flow.

It would also not be very useful to compare this company to a company that has a high percentage of its sales as credit sales.

Additionally, DSO is not always good at determining the efficiency of a business’s accounts receivable.

There is a useful alternative to DSO for assessing credit collection that businesses can use called Delinquent Days Sales Outstanding (DDSO).

It can also be used along with DSO.

It is a good idea for businesses to always use more than one metric when assessing their performance, if possible.

Next, we list answers to some questions concerning days sales outstanding.

How to Compute Days Sales Outstanding

To calculate DSO, divide accounts receivable for a certain period by the total dollar amount of the credit sales for the period.

After this, multiply the answer by the days in the period being considered.

What is Considered To Be a Good Days Sales Outstanding Ratio?

A good DSO ratio can differ depending on the industry a business is part of, but if the number is below 45, then it would be considered good in most industries.

It would indicate that the company has a reasonable cash flow it can use for generating more business.

How To Compute the DSO Ratio

A company had sales of $2,100,000 during the first three months of 2021, $900,000 of these sales were in accounts receivable and $1,200,000 in credit sales.

This is a period of 90 days.

The company’s DSO would be computed by dividing the accounts receivable by credit sales and multiplying this by the number of days.

$900,000/$1,200,000 = .75

.75 * 90 = 67.5

The DSO ratio would be 67.5

Why is Tracking DSO Essential?

If a company has a high days sales outstanding, it could mean that the cash flow of the company is not good.

What a good number is varies depending on the business, but typically a DSO of less than 45 is thought of as good.

However, it is better to look at how the number changes over time.

If the number is increasing over time, the company may have a problem in its collections department.

Although, it could also be caused by the company extending credit without sufficient care.

In either case, the company may end up having problems with its cash flow.

Tracking the DSO can encourage the payment department at a company to try to collect unpaid invoices.

It can also allow the department to find out which customers have poor payment records and flag them.

Final Thoughts

For a lot of businesses, days sales outstanding is crucial for determining how efficient the business is and if its cash flow is good.

Should the number of days sales outstanding become particularly high, it might create problems by interfering with the business’s operations, such as its ability to pay its own expenses.

Additionally, even if it continues to be able to pay its debts when payments are delayed, a company cannot reinvest as quickly, thus potentially losing money.

Key Highlights

• DSO represents how many days a business takes on average to receive cash payment for a credit sale.
• High days sales outstanding may indicate that a business is suffering from delays converting credit sales into cash, which may result in cash flow issues.
• Low DSO will generally indicate that a company is receiving payment for credit sales quickly, which is generally positive.