Days Sales Outstanding (DSO): Meaning, Formula, Calculation, Example

A successful business is all about money management and how various enterprise teams improve the cash flow.

One of the important parameters for improving the cash management of a business is DSO!

Let’s discuss some essential things that you need to know about DSO.

What is Days Sales Outstanding (DSO)? 

Imagine selling a product today and letting the buyer pay later. DSO measures how many days it takes, on average, for you to actually receive that money. 

DSO is a parameter that tells you about the average time that will take for your company to receive payment following a credit sale.

How to Calculate DSO?

You might have started getting eager about it. “How can I calculate my company’s DSO?”. 

To figure this out, we need to know some things beforehand.

1. The total amount of money customers owe you
2. Then, look at the value of goods sold on credit over a period, say, a month.
3. The number of days in the period.

Formula of DSO:

The formula for DSO is as follows-

DSO = (Accounts Receivable / Total Credit Sales) × Number of Days in the Period

Where,

Total Accounts Receivable is the amount of money that the customers owe.

Total Credit Sales is basically the net revenue.

Example of Days Sales Outstanding Calculation

Let’s try to understand them with the help of an example.

Imagine an enterprise selling furniture. At the end of June, customers owe the enterprise a total of Rs.5,000 for the furniture they bought on credit. So, this Rs.5,000 is their total accounts receivable.

Throughout June, the enterprise’s total credit sales were Rs.20,000. 

Now, let's calculate DSO for June, which has 30 days:

We know that, 

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

So, by using the formula: 

DSO = ( 5000 / 20000) × 30 = 7.5 days

This means, on average, the enterprise is getting paid in 7.5 days after making a sale on credit in June.

High DSO vs. Low DSO

The following table represents the differences between High DSO and Low DSO:

Benefits and Limitations of DSO:

 It is equally important for us to understand whether these DSOs hold any benefits or not. And do these also have some limitations? 

Benefits of DSO:

• Cash Flow Check: DSO can help us to keep our cash flow in check. How much sales are we turning into cash, which can lead our business to run properly.
• Spotting Payment Issues: A high DSO could signal that your customers are slow to pay, letting you tackle any issues before they get bigger.
• Better Financial Planning: When we know where our money is, and what is the estimated time by which we can expect it to be received, we can accordingly plan things for our business.
• Customer Relationships: By knowing our DSO, we can know how strong is our relationship with the customers. Low DSO means we have a strong relationship.

Limitations of DSO:

• It’s not the only factor: DSO will never tell you the entire picture. So, it is important that you must look at other financials alog with it as well.
• Industry Variances: What's a good DSO in one industry might not be great in another. So, comparing your DSO with others in your specific industry is key.
• Seasonal Fluctuations: Just like how some seasons are busier than others, DSO can change throughout the year. This means you might see different numbers in different periods.
• Can Be Misleading: Sometimes, a low DSO isn't always good news. It might just mean you're not making enough sales on credit.

How to Reduce Days Sales Outstanding (DSO)?

Prompt Invoicing: 

 As soon as you make a sale, send out the invoice. The quicker your customer gets the bill, the faster you can get paid. This also reduces confusion about when the payment is due.

Use multiple payment options: 

Keeping the accessibility of multiple options for payment can lead to quick and prompt collection of the accounts receivable, reducing DSO.

Clear Communication on Terms: 

Your invoices should clearly state the payment terms, like 'Please pay within 30 days.' This way, we can be clear with our due dates.

Incentives for Early Payment: 

Offering incentives for early payment can also help in reducing DSO, as extra incentives will make the customers more excited and valuable.

Regular Follow-Ups: 

We can remind the customers that their invoice is pending. A friendly email can help us remind them easily.

It is important to keep the DSO low, and we can do that by implementing the strategies discussed. But we must always remember that while a lower DSO is important, it's equally important to consider industry benchmarks and monitor changes over time so that we can make informed financial decisions.