Days Sales UncollectedDefined along with Formula & How to Calculate

Written By:
Lisa Borga

For companies that make sales on credit, it is important for both management, creditors, and investors to know how long it takes until they can expect to receive payment.

This average period of time until the cash payment is received is known as days sales uncollected, or in some cases, days sales outstanding.

This liquidity ratio is often calculated on a regular basis, such as monthly, quarterly, or annually and allows management to better plan for future spending.

Understanding Days Sales Uncollected

One of the most critical parts of running a business is managing its cash flow.

If cash inflows are insufficient to meet a company’s liabilities, it can lead to devastating consequences.

In addition, the time value of money means that cash received for a sale now is worth more than it would be the following day.

As a result, management generally benefits from a relatively short collection period for accounts receivable.

However, the period a company may expect to wait to receive payment varies considerably by industry.

In financial industries, a relatively large number of days sales uncollected are normal.

However, for agricultural industries, this period is generally relatively short.

In general, small businesses depend upon faster payment periods in comparison to large companies and, therefore, typically have a smaller number of days sales uncollected as well.

Though the average number of days sales uncollected can vary considerably by industry, generally, a period shorter than 45 days is considered relatively short.

For a company’s management, days sales uncollected can play a crucial role in planning for future expenses.

For investors and creditors, this ratio can be used in determining a company’s short-term liquidity and may play a role in deciding whether or not to extend credit to or invest in the company.

Calculating Days Sales Uncollected

Days sales uncollected are calculated by dividing accounts receivable by net sales and multiplying them by the number of days in the period under consideration.

The formula for this is:

Days Sales Uncollected = (Accounts Receivables / Net Sales) * Number of Days In Period

In order to calculate this, all that is needed is the total value of accounts receivable and net sales.

Accounts Receivable

This account records the amounts a company is owed from credit sales made to customers.

When a credit sale is made, customers have a period of time until a payment must be made, and sales will be removed from accounts receivable when a cash payment is received for a sale in its entirety.

The value of accounts receivable can generally be found by reviewing credit transaction logs and on the balance sheet.

Net Sales

Net sales represent the total revenue generated in a period.

This can typically be found on the balance sheet, and in some cases, the revenue on the income statement may solely represent net sales.

However, if this is not available, net sales can be calculated with the net sales formula, which is:

Net Sales = Gross Sales – Discounts – Sales Returns – Allowances

Using Days Sales Uncollected

Days sales uncollected can serve as a crucial indicator of a company’s liquidity.

Using the day’s sales uncollected formula, managers, creditors, and investors can quickly determine how effective a company is at collecting cash payments from customers.

The resulting ratio can serve as a quick reference for a company’s liquidity and cash flow.

Days sales uncollected can also serve as an indicator of customer satisfaction as well as whether a company’s current policies for extending credit may not be effective.

A high or increasing ratio may mean that current collection practices are ineffective or that salespeople are extending credit to customers with poor credit in order to increase sales.

It may also indicate that customers are unwilling to pay due to poor satisfaction, which could indicate further issues that should be confronted.

Though identifying days sales uncollected for even a single accounting period can offer valuable information, this may not identify trends or seasonal changes which occur.

By identifying trends in the collection period, early warning signs can be identified and issues resolved with minimum harm.

As a result, days sales uncollected should ideally be calculated monthly or quarterly in order to identify changes and trends early.

In many cases, a company’s collection period may face regular changes during the year, particularly for seasonal products.

Limitations of Days Sales Uncollected

There are limitations that must be considered when using days sales uncollected.

These include:

• When comparing companies using this ratio, it is important to consider that companies must be in the same industry, have similar revenues, and share similar business models for effective comparison.
• Companies with significantly different proportions of cash to credit sales cannot be effectively compared using this ratio.
• Days sales uncollected are calculated only with credit sales. If cash sales are used in the calculation, then it would reduce the ratio leading to an inaccurate result.
• On its own, this ratio only considers the volume and frequency of credit sales and therefore does not result in a perfect indication of a company’s efficiency at collecting on accounts receivable. Other metrics should be considered in addition to days sales uncollected when analyzing a company’s credit and collection practices.
• Economic factors outside of a company’s control can lead to a high or rising number of days sales uncollected, which can be misinterpreted as a poor credit policy or an ineffective collections process. Therefore, it is important to consider the possible causes of a high number, including external factors.
• The number of sales a company makes often varies seasonally. This means that the days sales uncollected will often fluctuate correspondingly throughout the year. As a result, the results from one period of calculations may not be representative of a typical result for other times of the year.
• Because some receivables may be overdue for far longer than a typical receivable, distribution must also be considered in making this calculation. Otherwise, a few receivables may result in a far higher result.

Advantages of Days Sales Uncollected

There are several advantages of using days sales uncollected as well.

These include:

• Days sales uncollected are easy to calculate and provide an immediate reference for the average number of days until cash will be received on a credit sale.
• This ratio can provide a simple reference for making informed decisions concerning the allocation of cash and the amount that must be kept in reserve to meet obligations based on when cash will be received on sales.
• Investors and creditors may use this ratio to determine a company’s short-term liquidity to make informed decisions when issuing credit or making investments. Companies and individuals are more likely to make investments or issue higher credit limits to companies with a shorter receivables collection period.
• Days sales uncollected can allow a company to identify trends that affect the collection period quickly before they disrupt business operations. This may include changes to policies for issuing credit or in the collections process.

Example of Days Sales Uncollected

As an example of days sales uncollected, consider ABC Caterers.

This company reports a sales revenue in October 20XX of $200,000, of which $150,000 are credit sales, and the remainder are cash sales.

As of the month’s end, the balance of accounts receivable is $100,000.

Using this data, ABC Caterers can calculate its days sales uncollected by dividing its accounts receivable by net credit sales and multiplying it by the 31 days in the period.

$100,000 / $150,000 = 20.67

ABC Caterers now knows that it generally takes approximately 21 days to collect cash payments on credit sales.

Though collection periods vary considerably based on industry, generally, a period of fewer than 45 days is considered low, so ABC Caterers’ management is satisfied.

Key Takeaways

• Days sales uncollected measures the average number of days after a sale is made on credit that it takes for a company to receive a cash payment.
• Generally, a large number of days indicates that a company may have difficulty in collecting payments which can lead to difficulty in managing cash flow.
• Companies generally benefit from a low number of days sales uncollected because the cash is then freely available for use in paying debts and investments.

In Conclusion

Managing cash flow is critical to preventing disruptions and ensuring continuing operations which makes awareness of collection periods critical.

As a result, management, creditors, and investors are interested in knowing a company’s days sales uncollected.

For management, this can serve as a crucial tool for planning expenditures and allocation of funds, as well as keeping abreast of possible trends in collection periods.

For investors and creditors, it can serve as an important tool for analyzing short-term liquidity in order to make educated investment and credit decisions.