|The Days Sales Outstanding (DSO) is a key performance indicator for the management of your accounts receivables. It is composed by two variables:
The DSO has a direct impact on the Working Capital Requirement (WCR), the cash and the overall risk to have unpaid invoices and bad debts.
Lower is your DSO, the lower is your WCR and your overall risk of unpaid customers. Impacts are a better cash flow and profitability.
The accounts receivables are a big consumer of cash for your company. The other big item consumer of cash that increase the working capital requirement is the inventory.
Calculate your DSOThe DSO is not a perfect indicator as it may be fluctuating because of many different reasons. However, it remains the main KPI to assess credit management performance. There are many methods of calculating DSO.
The roll back methodWe propose to use the most coherent and fairer calculation of DSO by depletion of accounts receivable by turnover.
Download the tool below to calculate your DSO with a few clicks or us the online tool.You can calculate your DSO for your accounts receivable but also for a group of client or for a single client (to assess his payment behavior for example).
Once the DSO is calculated, it is important to understand the reasons of its level. Has it increased because of longer payment term granted to customers? Or because more overdue invoices? Or due to less down payments received from customers...etc. This work analysis is key in order to take good initiatives to improve it.
Well understanding the DSO is essential to drive a proper actions plan!
The balance sheet methodThis is another classical way to compute the DSO. Its advandage is to be very simple and to be close to other financial ratios done on the balance sheet.
AR: Accounts receivable amount at end of the periodThe period chosen is often 3 months, ie 91 days. It is possible to perform the calculation over a longer period but the indicator is less accurate in this case.
If AR is 300, Sales of the period 200 and number of days of the period 91, the DSO is equal to 300 / 430 x 91 = 63.5 daysAdvantages of this method: the calculation is very simple to perform. In financial analysis, it can be done from the balance sheet and the income statement (with the period of the exercise).
Disadvantages of this method: the result is very volatile from one month to the next and it is strongly impacted by the variations of turnover, which is not representative of the performance in the management of the receivables. It is unwise to draw conclusions about a sudden drop or rise in this index. It must therefore be interpreted over the medium term taking into account, for example, a sliding average over 6 months.
How to improve your DSO?
Improving DSO represents an achievable Grail for businesses. Indeed, it is the main lever to reduce the Working Capital Requirement, and therefore improve the cash flow and the investment capacity of the company.
Main ways of DSO improvement:
ConclusionThe DSO is a key performance indicator in credit management and it can be calculated in several ways according to the method and the data taken into account (deduction of provision from the AR, adding of unbilled revenue to the sales, ...).
The understanding of the DSO results can be complex in some cases. See our article about the enigmas of the DSO.
Beyond to the cash and WCR stakes covered by the DSO, this indicator also shows the quality of the organization of a company. If it is too high, it may be due to lack of efficiency at one or several steps of the sales process.
Indeed, the "box" of overdue invoices is like a receptacle in which each invoice represents a malfunction in the sales process. Each overdue has a cause that can be the starting point to improve internal processes:
Next: overdue ratio calculation
This tool helps to have a clear understanding of Credit Management performance and evolution in your company.
- DSO calculation,
- Overdue ratio calculation,
- Bad debts ratio calculation,
- Cost of credit,
- Credit Management reporting.