Abbreviated as DSO, the Days Sales Outstanding metric is used to show the average number of days it takes to collect a payment after the company has made a sale. This metric is usually determined for a yearly, quarterly, or monthly period.
In short, the Days Sales Outstanding is a financial ratio that’s mean to illustrate/ show if the accounts receivables of a company are well managed. By analyzing this metric, a company/ business can round up the average number of days it takes for their customers to pay invoices.
The Basics of Days Sales Outstanding
Given the previously mentioned, we can safely assume that a company with a high Days Sales Outstanding ratio either has a customer base with credit problems or that the company itself is deficient when it comes to its collection’s activity.
On the other hand, a low ratio is not that good as well – for example, a low ratio can mean that the credit policy of the company is too rigorous, a fact that can later hamper the sales.
The Days Sales Outstanding is also used to measure the liquidity of a company/ business. A company with an increasing Days Sales Outstanding ratio means that the company is on its way to becoming less and less risk-averse. A high Days Sales Outstanding ratio can also mean that the analysis of the applicants for the open account credit terms has been done inadequately.
The Formula of Days Sales Outstanding
In order to calculate the Days Sales Outstanding metric, we can use two different formulas. For the first formula, we have to divide the accounts receivable by the total credit sales and then multiply the end result with the number of days for which we wish to know the Days Sales Outstanding Ratio.
Or, we could make things a little bit more complicated and first divide the total credit sales by the number of days and then divide the accounts receivable by the end result of the previous equation.
We all know the time value of money principle – basically, time is money and time spent doing nothing means lost money. Therefore, in the case of Days Sales Outstanding, where a company is waiting to receive money from its customers, as payment for certain products or services, the longer the time, the more money goes down the drain, so to say.
The Bottom Line
Of course, the money eventually gets to the company – but what matters is the availability of money and the time they should be available in. For example, if someone is taking too long to pay a certain sum, the company can’t rely on that sum when, let’s say, it makes a bid on a certain patent or item.
In short, the company can’t rely on the money they theoretically already have to pay for other things or to just use them in diverse operations.
Moreover, cash flow problems within the company can be avoided by selling fewer products/ services to customers on credit. Naturally, if a product is bought on credit, the company will have the money for it in a longer period.
In the end, by calculating the Days Sales Outstanding, the company can get a great overview of its internal cash flow and any potential issues.