How to Calculate Days Sales Outstanding (DSO)

Days Sales Outstanding (DSO) is a critical working capital metric that measures how efficiently a company collects cash from its credit sales. By calculating DSO, companies can better understand their cash flow cycles and make data-driven decisions to optimize liquidity.

In this comprehensive guide, we will walk through the step-by-step process of calculating DSO from start to finish.

What is Days Sales Outstanding?

Days Sales Outstanding represents the average number of days it takes a company to convert its credit sales into cash receipts. In other words, it measures the time between when a sale is made and when the payment is received by the company in cash.

A low DSO indicates the company is efficiently collecting cash from its customers. This improves free cash flow as there is less outstanding accounts receivable sitting on the balance sheet.

On the flip side a high DSO suggests the company is struggling to convert credit sales into cash quickly. The longer the time between the sale date and cash collection the higher the DSO value.

DSO provides critical insights into a company’s liquidity position. Companies want to minimize DSO as much as possible to reduce liquidity risk and boost cash flow available for investments.

Days Sales Outstanding Formula

The days sales outstanding formula is calculated as follows:

DSO = (Average Accounts Receivable / Net Credit Sales) x Number of Days

Where:

• Average Accounts Receivable = (Beginning AR + Ending AR) / 2
• Net Credit Sales = Total Credit Sales – Returns – Discounts

To calculate DSO on an annual basis, the number of days is typically 365. However, you can use shorter time periods like quarterly or monthly as well.

Let’s break down each component

Numerator – Average Accounts Receivable

The numerator represents the average outstanding accounts receivable balance during the measurement period.

To calculate average AR, you take the beginning AR balance plus the ending AR balance and divide by 2. This matches the timing of the cash collections from customers to the credit sales.

Only the credit sales portion should be considered for DSO, so any cash sales are excluded.

Denominator – Net Credit Sales

The denominator represents the total credit sales made during the period. However, you want to deduct any returns or discounts to arrive at net credit sales.

This represents the total value of credit sales that are still owed to the company in cash.

Number of Days

Finally, you multiply the AR/Sales ratio by the number of days in the measurement period. Typically, this is 365 days when calculating on an annual basis.

This gives you the average number of days it takes to collect cash from credit sales made during the year.

DSO Calculation Example

Let’s walk through an example DSO calculation for a company’s 2020 fiscal year:

• Beginning AR on January 1, 2020 = $20,000
• Ending AR on December 31, 2020 = $30,000
• Total Credit Sales in 2020 = $200,000
• Returns = $5,000
• Discounts = $10,000

Step 1: Calculate Average AR

Average AR = (Beginning AR + Ending AR) / 2
= ($20,000 + $30,000) / 2
= $25,000

Step 2: Calculate Net Credit Sales

Net Credit Sales = Total Credit Sales – Returns – Discounts
= $200,000 – $5,000 – $10,000
= $185,000

Step 3: Calculate DSO

DSO = (Average AR / Net Credit Sales) x 365 Days
= ($25,000 / $185,000) x 365
= 49 Days

Therefore, this company takes ~49 days on average to collect cash receipts from its credit sales.

What is a Good DSO?

What is considered a “good” DSO varies significantly across different industries. Companies want to minimize DSO, but the averages can range quite a bit.

For example, a DSO of 30 days may be standard in the software industry. But a manufacturer selling large equipment may see DSOs of 90+ days.

The most important analysis is looking at DSO trends over time and benchmarking against competitors in the same industry.

If your DSO is increasing while peers remain steady or decreasing, it may indicate inefficiencies in credit and collections.

Some general DSO benchmarks:

• DSO < 30 days – Excellent cash collection
• DSO 30-60 days – Efficient and in line with most industries
• DSO 61-90 days – Potential inefficiencies, monitor trends
• DSO > 90 days – Poor cash collection, review credit policies

How to Reduce DSO

For companies with high DSO, here are some strategies to help improve collections and reduce days sales outstanding:

• Offer discounts for early payment – Give customers incentives to pay invoices faster. Even small discounts can improve timing of payments.

• Enforce stricter credit policies – Review credit history more thoroughly before extending terms. Require deposits or down payments.

• Shorten payment terms – Instead of net 30, require payment within 15 or 20 days to receive goods or services.

• Invoice promptly – Send invoices as soon as possible after the sale is made. Follow up frequently on past due invoices.

• Ban problematic customers – Refuse to do business with customers who consistently pay late. Protect yourself from chronic late payers.

• Accept credit card payments – Get paid instantly rather than waiting for checks to clear.

DSO Calculator

Below is an example DSO calculator you can use to quickly calculate days sales outstanding.

Simply input your beginning AR, ending AR, total credit sales, returns, and discounts for the period, and it will automatically calculate the average DSO.

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