Days' Sales Outstanding

Definition

Days’ Sales Outstanding (DSO) is a key measurement used to ascertain the efficiency of a company’s credit and collections efforts. Specifically, it measures the average number of days it takes a business to collect payment after a sale. A lower DSO number generally indicates a shorter time to collect accounts receivable, which means improved cash flow and more effective accounts receivable management.

The DSO is calculated using the following formula:

DSO = (Accounts Receivable / Total Sales) * Number of Days

Examples

Example 1:
- Company A:
  - Total Sales: £500,000
  - Accounts Receivable: £50,000
  - DSO Calculation for 30 days:
```
DSO = (£50,000 / £500,000) * 30 = 3 days
```
  - This means Company A takes approximately 3 days to collect its outstanding sales on average.
Example 2:
- Company B:
  - Daily Sales: £5,000
  - Accounts Receivable: £50,000
  - DSO Calculation:
```
DSO = £50,000 / £5,000 = 10 days
```
  - Company B takes about 10 days to collect its receivables on average.

Frequently Asked Questions (FAQs)

What is a good DSO value?
- A good DSO value depends on the industry standard. Generally, a DSO under 45 days is considered favorable, indicating efficient collection processes. Comparative analysis should be context-sensitive and industry-specific.
How can a company improve its DSO?
- Companies can improve DSO by improving their invoicing process, offering discounts for early payments, strengthening their credit policies, and intensifying collection efforts.
What are the consequences of a high DSO?
- A high DSO can indicate problems with cash flow, the potential for defaulted payments, and inefficiency in the collection process. It may also suggest lenient credit terms or ineffective collections policies.
How frequently should DSO be calculated?
- DSO should ideally be calculated on a monthly basis to provide consistent and up-to-date information on the company’s collections performance.

Accounts Receivable (AR): Money owed to a company by its debtors for goods or services sold on credit.
Cash Flow: The net amount of cash being transferred into and out of a business.
Credit Management: The process of granting credit, the terms on which it is granted, and the recovery of the credit when it is due.
Turnover Ratio: A financial ratio that measures company’s efficiency in turning its accounts receivable into cash.

Online References

Suggested Books for Further Studies

“Financial Intelligence: A Manager’s Guide to Knowing What the Numbers Really Mean” by Karen Berman and Joe Knight
“The Essentials of Finance and Accounting for Nonfinancial Managers” by Edward Fields
“Accounting Made Simple: Accounting Explained in 100 Pages or Less” by Mike Piper
“Financial Statement Analysis and Security Valuation” by Stephen Penman

Accounting Basics: “Days’ Sales Outstanding” Fundamentals Quiz

### DSO is used to measure the efficiency within which business practice? - [ ] Inventory management - [ ] Customer satisfaction - [x] Accounts receivable collection - [ ] Workforce productivity > **Explanation:** Days' Sales Outstanding (DSO) measures the efficiency of a company’s accounts receivable collection process, indicating the average number of days taken to collect payment after a sale. ### What is the formula used to calculate DSO? - [ ] (Accounts Payable / Total Sales) * Number of Days - [x] (Accounts Receivable / Total Sales) * Number of Days - [ ] (Total Sales / Accounts Receivable) * Number of Days - [ ] (Net Income / Total Sales) * Number of Days > **Explanation:** DSO is calculated as (Accounts Receivable / Total Sales) * Number of Days, measuring the average time taken to collect payment post-sales. ### If Company C has accounts receivable of £100,000 and total sales of £1,200,000 over 360 days, what is its DSO? - [ ] 20 days - [ ] 25 days - [x] 30 days - [ ] 35 days > **Explanation:** ``` DSO = (£100,000 / £1,200,000) * 360 = 30 days ``` Company C takes on average 30 days to collect its receivables. ### High DSO values are indicative of which potential company issue? - [x] Poor cash flow - [ ] Excellent credit control - [ ] High inventory turnover - [ ] Strong profit margins > **Explanation:** A high DSO typically indicates poor cash flow maintenance and inefficiencies in collecting accounts receivable. ### What DSO value is generally considered favourable across industries? - [ ] Over 60 days - [x] Under 45 days - [ ] Between 50 and 60 days - [ ] Exactly 30 days > **Explanation:** Generally, a DSO under 45 days is viewed favourably, highlighting efficient accounts receivable processes. ### To calculate DSO, which financial metric is NOT required? - [ ] Accounts Receivable - [ ] Total Sales - [ ] Number of Days in period - [x] Net Income > **Explanation:** Net Income is not needed to calculate DSO. The calculation requires the total sales, accounts receivable, and the number of days in the period. ### Which of the following actions could reduce a company’s DSO? - [ ] Extending more credit to customers - [x] Offering discounts for early payments - [ ] Reducing inventory - [ ] Increasing marketing expenditure > **Explanation:** Offering discounts for early payments encourages customers to pay promptly, effectively reducing the DSO. ### Which aspect of a business does DSO directly impact? - [ ] Employee productivity - [x] Cash flow - [ ] Marketing spend - [ ] Capital structure > **Explanation:** DSO directly impacts cash flow by affecting the speed at which a company can convert its receivables into cash. ### What does a low DSO suggest about a company? - [x] It collects payments quickly - [ ] It has poor credit management - [ ] High level of unpaid debts - [ ] Ineffective sales team > **Explanation:** A low DSO indicates quick payment collection, highlighting effective credit and collections processes. ### In what financial statement are accounts receivable, used in DSO calculation, found? - [ ] Income Statement - [x] Balance Sheet - [ ] Cash Flow Statement - [ ] Statement of Retained Earnings > **Explanation:** Accounts receivable is found on the Balance Sheet, reflecting money owed to the company by its customers.