Days Sales Outstanding (DSO)

Days Sales Outstanding (DSO) is an important financial metric that shows how efficiently the company manages its accounts receivable. By predicting the average number of days any company takes for the collection of payments from the customer after sale, DSO delivers the signal for steady cash flow. Enhancing DSO is crucial for the prosperity and financial stability of the company.

What is DSO?

DSO (days sales outstanding) is the average number of days to receive the payments from customers taken by any company that made a sale on credit.

The lower the number of DSOs, the shorter the time for the collection of payments by the company from its customers, while on the other hand, the higher the DSO, the more time is taken by the company for the collection of payments from customers, which shows that collections processes are not handled correctly.

Days Sales Outstanding formula

The formula to find the days sales outstanding is by dividing the average accounts receivable balance by revenue for the provided period of time, and the solution is multiplied by the number of days in that period.

For an instance a company with a revenue of 50 lakhs and the average AR balance for the year is 5 lakhs. Then the calculation will be

= 50,000,00/5,000,00 x 365 days = 36.5 days

The importance of DSO for company

Finding days sales outstanding is one of the crucial tasks for any company to find out the efficiency of the account receivable team. Here are some key points that illustrate the importance of Days Sales Outstanding (DSO) for companies: –

Enhancing Cash Flow Management

To keep cash flowing smoothly, you need to know exactly when your Days Sales Outstanding (DSO) starts climbing. Spotting trends early lets you fix issues fast, working hand-in-hand with accounting and customer success teams to tighten up payment cycles.

Assessing Customer Credit Risks

Tracking DSO trends gives a clear picture of customer credit risk. If your DSO starts creeping up, it could mean clients are struggling to pay on time, or there’s something off in your own collections process. Either way, it’s a red flag you can’t ignore.

Benchmarking Your Performance

Comparing your DSO to internal goals and industry benchmarks, especially in SaaS, can tell you how well you’re doing. Don’t obsess over competitors, but having a baseline helps you see where you stand.

Optimizing Billing and Collections

Keeping an eye on your DSO can expose gaps in your invoicing and collections strategies. Maybe your billing process is too slow, or your follow-ups aren’t sharp enough. Fixing these issues will speed up payment cycles and free up cash.

What Does a High DSO Mean?

A high DSO means you’re waiting too long to get paid after making a sale. Here’s why that’s bad:

Cash Flow Takes a Hit: When invoices aren’t paid, cash gets stuck in accounts receivable, leaving you with less money to cover costs or invest in growth.

Inefficient Collections: A high DSO often points to problems in how you handle collections. It might be that your invoicing is slow, you’re doing too much manually, or you’re not keeping communication tight with customers on payment terms.

Credit Risks: If customers are always paying late, it’s a sign they might be higher risk. You may need to reconsider their credit terms or tighten your policies to reduce the risk of bad debt.

What Does a Low DSO Mean?

A low DSO? That’s usually a good sign. It means your business is getting paid quickly, which boosts cash flow and keeps things running smoothly. You’ve got more liquidity to invest in growth or handle day-to-day expenses without stress.

Here’s why you might have a low DSO:

Streamlined Invoicing: If you’re sending out invoices quickly and following up efficiently, you’re reducing the time between making a sale and collecting the cash.

Favorable Payment Terms: Offering things like early payment discounts or shorter payment cycles can encourage clients to pay sooner, cutting down your DSO.

High-Quality Customers: Working with reliable clients who pay on time means you won’t be stuck waiting for payments, keeping your average collection time short.

Questions to Understand your ability

Que.1  What exactly does DSO (Days Sales Outstanding) track for a company?

A) How many days the company operates in a year

B) The time it takes to pay off suppliers

C) The average number of days a company waits to get paid after making a sale on credit

D) The number of days it takes to complete sales orders

Que.2  What’s the downside of having a high DSO?

A) Cash keeps flowing fast

B) Customers pay quicker than expected

C) Cash is stuck in accounts receivable, slowing down the business

D) Invoices are cleared faster, improving cash flow

Que.3 How do you calculate DSO?

A) Average accounts receivable / Revenue x Number of days

B) Revenue / Average accounts receivable x Number of days

C) Revenue / Total sales x 30 days

D) Total sales / Net profit x 365 days

Que.4  What does a low DSO usually mean for a business?

A) Collections are slow and cash flow is tight

B) Customers are paying fast, cash flow is strong

C) You’re facing credit risk from most customers

D) There’s a major delay in sending invoices

Que.5 What’s one smart move to bring down your DSO?

A) Offer longer payment terms to customers

B) Wait longer to send out invoices

C) Give early payment discounts and send invoices right away

D) Ignore customer payment trends and hope for the best

Conclusion

With the help of Days Sales Outstanding, companies get the signal that some type of inefficiency is happening in the collection processes and their implementations. Reducing DSO is crucial, and it can be achieved with the help of automation, health conversations with customers, and the revised credit policies. This brings steady cash flow as well as operational agility.