What Is DSO? How To Calculate Days Sales Outstanding
How To Calculate DSO
The longer it takes a company to be paid, the more they stand to lose. That’s because the company misses out on the opportunity to use that money for their own ends, whether it be paying overhead costs or reinvesting into the business. In other words, a dollar today is worth more than a dollar in 60 days.
Calculating DSO helps companies stay aware of these timelines by measuring how many days it takes to receive payments over any given period. It takes just four steps to calculate DSO:
- Determine the period you want to measure: DSO is often used annually, but can be applied to shorter periods, even down to one month. The calculation always uses the number of days in the period.
- Identify the accounts receivable balance for that period: This is the amount owed to your company for the service provided to the customer on credit.
- Identify the total credit sales for that period: This revenue excludes sales paid for in cash since there were no days that the payment was outstanding.
- Enter the data points into the DSO formula: The result will tell you how many days on average it takes your company to retrieve payments from customers.
Comparing a DSO calculation to previous periods can assist in finding market trends, enabling companies to anticipate customer performance, such as late payments.
How To Use the DSO Formula
Look to the example below for a walk-through on how to calculate DSO:
Company X has $300,000 in credit sales and $50,000 in accounts receivable for the first three months of the year.
How would Company X measure their DSO for this period?
First, they’d need to divide the accounts receivable by the credit sales:
50,000 / 300,000 = 0.17
Then they’d multiply that value by the number of days in January through March:
0.17 x 90 = 15.3
Company X’s DSO for this period is 15.3.
How To Interpret Good and Bad DSO
In general, companies are always looking to reduce their days sales outstanding to the lowest possible figure, in light of their customers ability and willingness to pay. This shows that their processes are efficient, resulting in more timely payments.
A high DSO number results in lower cash flow for the company. Companies in this situation should look at ways to improve their collections processes so they can increase their liquidity.
For perspective, in the third quarter of 2022, the national DSO average was 37.3 days. However, what’s considered a high or low DSO for a company is largely dependent on the industry in which it operates. For instance, the agriculture industry relies on relatively fast payments compared to industries that are not affected by weather or spoilage.
The size of a company within an industry is also important to note. A small business is more likely to operate on tight cash flow than a large, well-established corporation, so comparing their DSOs is not as practical.
Plus: Average DSO in Different Industries
See how your business compares to the average DSO in your industry by looking to the chart below:
