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Days Sales Outstanding (DSO) Formula and Explanation
The effort needed to find the right measure of outstanding accounts receivable is common for creditor companies. Days Sales Outstanding is a measure of the average number of days that a company takes to collect after sale have been made on open account terms. A low DSO means that it takes a relatively short time to collect accounts receivable. A high DSO indicates it is taking longer for the creditor company to collect its accounts receivable. What is considered an acceptable or unacceptable DSO depends on any number of factors. Average DSO varies from industry to industry. It is affected by any number of factors such as whether the creditor company sells only domestic accounts or sells domestically and internationally.
A declining DSO is considered positive because the creditor company is converting its accounts receivable into cash quickly. An inncreasing DSO is a negative since it indicates the company under review may be having difficulty converting accounts receivable into cash. A high DSO might also indicate problems in the creditor company's operations resulting in delays in payments or in chargebacks. Some of the more common operational problems include: pricing errors; shipping errors; late delivery; early delivery; short shipments; incorrect payment terms; and shipment of defective merchandise.
The DSO Formula is:
[Ending Accounts Receivable Balance / Sales] Times the number of days in the period
DSO is affected by a number of factors beyond the control of the credit department including:
- The timing of sales;
- Increases or decreases in sales volume;
- Seasonality, meaning variability in sales that recur each year;
- A higher or lower volume of disputes and deductions;
- Extended dating terms offered to customers;
- General economic conditions;
- Whether the company sells only domestically or sells both domestically and internationally;
- The creditor company's sensitivity to credit risk, delays in payment, or payment default.
Edited by Michael C. Dennis