7 Things to Know About Your Days Sales Outstanding
May 11, 2022
Tracking Accounts Receivable metrics is essential to your business. Indeed, it allows you to monitor your cash collection process and manage your cash flow better. It also helps you mitigate the risks of the inevitable late-paying accounts. In short, keeping track of essential KPIs helps you plan for your business growth.
One of the essential KPI to follow from the start is your DSO - for Days Sales Outstanding. Simply put, your DSO is the number of days it takes for your business to get paid.
What exactly is DSO?
Which ways can you calculate it?
What does an ideal DSO look like?
Keep reading to learn the 7 things you need to know about your Days Sales Outstanding.
With Upflow, you can get live and direct access to your DSO through your dashboard. Our in-house software helps you automate your A/R collection process and gives you your real-time KPI, so you can focus on your long-term strategy. Give it a try with our free analytics platform!
1. What is Days Sales Outstanding?
Days Sales Outstanding is the time it takes you to get paid by your customers, counted in days.
Concretely, it is the number of days between your invoice being issued and your invoice getting paid - ie when your company’s accounts receive the credit sales from your customers.
Your DSO is a key metric in your cash conversion cycle, alongside other important KPIs to track in your B2B business.
2. Why is DSO Important for Your Accounts Receivable?
Your DSO is an important financial ratio to track as it’s a good indicator of your company’s cash flow. By knowing your average collection period, you’ll be able to plan how much cash flow you can expect at a given time.
It also tells you how efficient your collection process and payment terms are, which is key for optimizing your overall accounts receivable process.
Your DSO, combined with your turnover ratio (calculated from your net credit sales), also tell you how well you can turn your accounts receivable into cash over a given time period.
Your DSO and receivable turnover ratio are complementary KPIs. Looking at both allows you to understand how well your cash collection process is operating based on 2 fundamental things:
the number of days it takes to collect revenue from the sale,
the efficiency of your process comparing your net sales and your A/R.
As it heavily influences your working capital, your DSO can make or break your business. When it’s low, it’s a sign that your conversion from invoicing to cash sales goes smoothly. When it’s high, it’s a warning sign of poor collections processes and needs to be addressed ASAP.
Need help calculating your main A/R metrics? Have a look at our free spreadsheet.
3. How Do You Calculate Your DSO?
There are two different ways to calculate your days sales outstanding: the simple method and the countback method.
Both require your balance sheet numbers like your accounts receivable and gross sales, so get those ready!
Days Sales Outstanding Formula: the Simple Method.
Let’s start with the simple one: as its name indicates, it is the most straightforward to use.
For this, you’ll need your gross revenues and your accounts receivable at the end of the period you want to calculate.
The formula for calculating your DSO using the simple method is:
Let’s take an example:
Your gross sales on December 31st are $5,000,000.
Your accounts receivable at the same date are $500,000.
Using the simple method formula, your DSO is:
$500,000 / $5,000,000 * 365 = 36,5 days.
Over that year, 36,5 was the average number of days it took your company to get paid by its customers.
While this method is the simplest, it has one major drawback: it doesn’t take into account any seasonality in your business. For that, you’d need to calculate your DSO over different timeframes, which defeats the point of simplicity.
Let’s have a look at a more accurate DSO formula next.
DSO calculation: How to use the Countback Method.
The countback method is the most accurate way to calculate your DSO. Unlike the simple method, it isn’t based on an average. Instead, it goes back in time month by month to find exactly your days sales outstanding over a period of time.
You need the same numbers as before, namely your accounts receivable balance and your gross sales at the end of your selected period - but this time for every month.
From there, you have two options:
Your accounts receivable is superior to your gross sales: in this case, you can add the number of days in the month straight to your DSO calculation (eg: 30 days).
Your accounts receivable is inferior to your gross sales: here, you calculate a ratio between your accounts receivable and your gross sales and multiply the result by the number of days in the month.
Start with the later month and go backward in time until your gross sales is superior to your A/R. The number you have in your DSO there is your final dso value.
Let’s take an example:
In May, your accounts receivable are higher than gross sales. You can add the days of the month straight to your DSO calculation. You then remove your gross sales from your A/R balance to report it to the following month's A/R.
DSO = 31 days.
$11,000 - $3,000 = $8,000 reported in A/R in June.
In June, your A/R is again higher than gross sales. You can again add the days of this month to your DSO. Then, you cut down your gross sales from your accounts receivable to report it to the next month’s accounts receivable.
DSO = 61 days.
$8,000 - $1,000 = $7,000 reported in A/R in July.
In July, your A/R is lower than your gross sales, so you calculate a ratio between both to find out the number of days to add to your DSO. For this, you use the DSO calculation formula used in the simple method:
$7,000 / $10,000 * 31 days = 21
DSO = 82 days (61 + 21 days)
That’s it! You’ve calculated your DSO: 82 days is the time it takes to convert your invoices into cash.
Do you want to know more about how to calculate your DSO? Check out our article: DSO: A step-by-step guide to calculating Days Sales Outstanding
4. What Does a Low DSO Mean?
Is a Low DSO a Good Thing?
A low DSO is good news for your business!
It means your customers respect your payment terms, which in turn is a good indicator of their satisfaction with the service/product you provide. In return, you’ll be able to make the most of your cash flow and pay your suppliers on time.
A low DSO is therefore an indicator of a fast cash conversion cycle and good liquidity. Companies with a low DSO have their credit policy respected and are able to make the most out of their cash flow, investing it wisely to finance their growth.
A lower DSO is a sign of good financial health - and investors like that!
What Does a Low DSO Look Like?
Your best possible DSO is one close to your payment terms.
If you have a subscription-based business and most of your clients have an automatic payment set up, your DSO might be zero days. If your clients pay you after 30 days, then having a DSO at 30 days is great, too.
In summary, it’s all relative! Different industries will have different high or low DSO. You can find a benchmark of the average dso by industry here.
5. What Does a High DSO Mean?
If your DSO varies too far from your payment terms or credit policy, you have a problem: your company is taking too long to collect cash from its customers.
In startups and scale-ups, there is often an emphasis on the sales team’s efficiency and the net credit sales. However, it’s your actual cash collection that’s key to sustainable growth.
A high DSO shows you are basically extending an interest-free loan to your clients. It’s cash you could be using for paying your own suppliers or investing in other projects.
A higher DSO than your payment terms means you’re at risk of running into cash flow problems, especially if you are growing fast.
And since overdue invoices are more likely to never get paid, you also face the risk of never seeing the money your clients owe you. To prevent this, you can set up payment reminders for your clients, which will help lower your risk and your DSO.
You’ll find more tips on lowering your DSO in the next part.
6. How to Improve Your DSO?
If you want to lower your DSO, you have to look at your average accounts receivable process: what does your customer have to do to pay you?
The easier you can make it for your customer to pay you, the better. Here are a few tips to lower your DSO:
Setting up an efficient invoicing and payment process. Send clear invoices that outline your payment terms and payment methods. Always include the due date and clear instructions to pay you, as well as contact information if there is a problem. Offering various payment options is also a good idea.
Use incentives for early or upfront payment: it’s the opposite of punishing your customer for paying late (i.e. charging late payment fees). Offering a discount on their invoices for early or upfront payment creates a win-win situation for everyone. You can decide on an amount of time where they get an incentive and simply inform your customers of your new policy.
Send collection emails: being proactive about your overdue invoices will lower your DSO. You can send emails before the due date, or when your invoice is past due. Trust us, your receivable balance will benefit from it!
7. Is a Spreadsheet Enough to Calculate DSO?
Using a spreadsheet to find your DSO ratio is tempting - after all, which finance person doesn’t use Excel? Is Excel the most efficient to calculate your DSO, however? No.
Using spreadsheets to calculate your DSO.
In a nutshell, using spreadsheets for this purpose is too time-consuming and not accurate enough.
To get your company’s DSO number, you need your accounts receivable balance as well as your gross sales over a period of time. They might be available on your financial statements already, but what if you want to calculate your DSO over the current period or a projected period of time?
The point here is that finding the most accurate numbers can be tricky and lead to errors. Plus, switching between various spreadsheets to chase up-to-date numbers isn’t the best use of anyone’s time.
If you choose to use the countback method (which we recommend), it also requires quite a lot of time to calculate. It’s much easier, and faster, to use an automated solution.
Automating your DSO calculation.
Regardless of the way you choose to calculate your days sales outstanding, what matters most is to be consistent in your measurement.
It’ll give you insights into your business and allow you to course-correct sooner rather than later. Less time spent on calculation, more on action is how we roll.
A tool like Upflow calculates your DSO for you in real-time, making it easy to know your dso number at any time. That’s especially handy if you’re preparing a financial report for your CEO or board. More importantly, it saves you time, which you can spend on strategizing and problem-solving.
Your Days Sales Outstanding measures the days it takes your clients to pay their invoices. It’s a very important A/R KPI as it indicates your liquidity.
Tracking your DSO allows you to better manage your cash flow. A low DSO is ideal, whereas a high DSO can lead to cash flow problems.
A DSO can be relatively high or low depending on your industry. As a rule, the closer your dso number is to your payment terms, the better.
You can calculate your DSO value using the simple method or the countback method. The latter is more accurate but also takes more time.
To lower your DSO, you need to make your invoicing and payment processes a breeze for your clients. You can also set up incentives for upfront or early payments and/or start sending payment reminders.
Even though spreadsheets might seem the first choice to calculate your DSO, it’s not the best one as it’s error-prone and time-consuming. A better alternative is using automated software, like Upflow.