Days Sales Outstanding (DSO) and how to halve it

Days Sales Outstanding (DSO) and how to halve it

Days Sales Outstanding, or DSO, is the average number of days for a business to collect a cash payment from a credit sale. When a business sells on credit, it gives its customers permission to pay in cash at a later date. The average time to pay for a given period is the days sales outstanding.

The days in sales outstanding impacts cashflow. For example, a high DSO means a business has taken a long time to convert its accounts receivable to cash. Cashflow-conscious businesses will strive to reduce DSO. A lower DSO means cash returns to the business faster.

Key points

  • Days Sales Outstanding is common accounts receivable term often referred to as DSO.

  • DSO is the average number of days for a business to convert a credit sale to cash in the bank.

  • The days sales outstanding formula is (Average Account Receivable / Total Credit Sales) x Number of days.

  • You can lower DSO to achieve better cash inflow with strict credit control and a disciplined accounts receivable process.

What is the days sales outstanding formula?

The days sales outstanding formula is easy to run. It’s a measure of how quickly cash was recovered from outstanding sales invoices. Sales revenue may be a combination of cash sales and credit sales. Only credit sales (accounts receivable) are considered in the DSO formula. That’s because cash sales are not counted as outstanding. DSO is typically measured month-by-month.

DSO = (Average Account Receivable / Total Credit Sales) x Number of days

You can see that if a business retains a high proportion in accounts receivable at the end of one month, its DSO will be high. It has not converted its credit sales into cash quickly and that money is not available to run the business.

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A days sales outstanding example

Here’s how we arrive at a DSO calculation of 40 days for ABC Wholesale Company:

  1. We decide to calculate the DSO for the month of June, which has 30 days.

  2. On 1 June there was $105,000 in accounts receivable.

  3. On 30 June there was $95,000,00 in accounts receivable.

  4. We calculate the average value in accounts receivable for June was $100,000 (the average of $105,000 and $95,000).

  5. In June, ABC Wholesale Company recorded $75,000 in total credit sales.

  6. DSO = (100,000 / 75,000) x 30 days = 40 days

ABC Wholesale Company takes 40 days on average to collect a credit sale. 

Even without the calculation we can quickly understand that ABC Wholesale Company is accruing more debt in relation to its credit sales for the month.

Imagine ABC Wholesale Company’s cash position if it halved its DSO to 20 days?

How to halve days sales outstanding

To halve its calculation of DSO to 20 days, ABC Wholesale Company can effect change upon two  variables in the formula. Most simply, it could:

  1. Halve the average accounts receivable, or

  2. Double the total credit sales.

Let’s see what happens when the business halves its average accounts receivable by collecting twice as much:

DSO = (50,000 /75,000) x 30 days = 20 days

Or, ABC Wholesale Company could also halve its DSO if it doubled its credit sales:

DSO = (100,000/150,000) x 30 days = 20 days

Doubling sales is a big ask! While it’s always great to double sales, that doesn’t equate to an improvement in the accounts receivable department’s collection efficiency. And collecting payments faster is ultimately the goal of lowering DSO.

The good news is that halving accounts receivable is achievable with strict credit controls and a disciplined accounts receivable process. 

What is a high DSO?

‘High’ and ‘low’ days sales outstanding ratios are best considered in a wider context:

  • Industry: Some industries are much slower to pay than others.

  • Trends: Seasonal businesses experience highs and lows in their collections and sales, so compare DSO over comparable periods to determine acceptable highs and lows.

  • Business size: A DSO of 60 days may be ‘good’ for a large business but crippling to cashflow for a small business.

  • DSO can mask a bigger picture. We cover more considerations in our blog post on accounts receivable turnover ratio.

Why does a low DSO matter?

DSO is one measure of the liquidity of a company: how much access it has to cash to operate day-to-day. Small to medium-sized businesses rely on cash to pay their people, re-stock, and upgrade their systems. Lowering the days sales outstanding means that the cash conversion cycle is faster. There is more cash returning to the business each month, and that cash is available to fund business operations.

Without good cash recovery, it is harder to fund the activities that support an increase in sales.

What’s more, investors and creditors want to know that a business is effective in managing its debts. Cashflow is a critical indicator of a business’s health and financial outlook.

How to improve days sales outstanding

Days sales outstanding is not all about numbers! A big influence on payment times is your debtor communications and relationships.

It’s a fact we prove over and over at ezyCollect: debtor relationships matter!

You can improve (lower) your days sales outstanding by improving your service offer to debtors. Once your accounts receivable process becomes easier for you and your debtors, payment times improve.

Here are five simple tips:

1.  Understand every new debtor’s likelihood to pay on time BEFORE you issue credit. This way, you are not exposing your business to known late payers and are offering your credit to buyers who are likely to pay on time.

2.  Digitise your invoicing and payment chasing. These are both inevitable activities if you offer trade credit so automate your accounts receivable tasks for speed and accuracy and get those collection communications to your customers on time, every time.

3.  Use collection calls and SMS reminders to connect with debtors.  When emails aren’t enough, your workflow needs to accommodate a timely and effective collection call and an SMS payment reminder to cut through the noise.

4. Offer your customers payment convenience. Pay later, pay with credit card, pay online. This is what business customers want and if you’re not offering these payment methods, just know that someone else is. Guess who gets paid first?

5. Say thank you for paying. This simple gesture is so powerful and yet often under-estimated. If you could be the business that simply says ‘thanks”why wouldn’t you? You can even personalise and automate your message to make sure you never miss an opportunity to reinforce positive payment behaviour.

In summary:

An increasing DSO indicates that debtors are taking longer to pay their invoices. Long and late payment times limit a business’ access to vital cashflow to survive and thrive. Cashflow can improve when DSO is reduced and the cash conversion cycle speeds up.

To solve DSO issues, a business can improve its credit risk management and collections efficiency.

ezyCollect is purpose-built to reduce Days Sales Outstanding