Days Sales Outstanding (DSO)

What is Days Sales Outstanding

Days Sales Outstanding (DSO) is a financial metric used to measure how quickly a company can collect payments from its customers. It is often used to assess the creditworthiness of a company and its ability to pay its bills. It is also used to measure the company's liquidity and financial position. DSO is calculated by dividing the average accounts receivable balance by the total net credit sales for a given period.

Why Days Sales Outstanding is important

DSO is important because it helps to assess a company's ability to manage its financial obligations. If a company has a high DSO, it means that it is taking longer to collect payments from its customers and that it may be having difficulty managing its liquidity. DSO can also provide valuable insights into the company's business operations and its ability to generate cash.

How Days Sales Outstanding is calculated

Days Sales Outstanding is calculated by dividing the average accounts receivable balance by the total net credit sales for a given period. This can be expressed as a formula:

DSO = Average Accounts Receivable Balance / Total Net Credit Sales

For example, if a software company has an average accounts receivable balance of $2 million and net credit sales of $3 million, its DSO would be calculated as follows:

DSO = $2 million / $3 million = 0.67

This would mean that the company is able to collect payments from its customers in 67 days on average.

How to improve Days Sales Outstanding

There are several ways to improve a company's DSO. The most effective way is to ensure that customers pay their invoices on time. Companies can also offer incentives to customers to encourage them to pay their invoices promptly. Additionally, companies can implement credit policies and procedures to ensure timely payment by customers.

Why investors value low Days Sales Outstanding

Investors typically prefer companies with low DSOs because it indicates that the company is able to collect payments from its customers quickly. This is important because it means that the company is able to generate cash flow more efficiently and is better able to meet its financial obligations. A low DSO also indicates that the company is likely to have a healthier balance sheet and is less likely to experience cash flow problems.

How Days Sales Outstanding relates to other financial metrics

DSO is closely related to other financial metrics such as accounts receivable turnover, debt collection period, and current ratio. A low DSO indicates that a company is able to collect payments from its customers quickly, which can have a positive effect on these other metrics.

Sources

• Investopedia, “Days Sales Outstanding (DSO)”, https://www.investopedia.com/terms/d/days-sales-outstanding.asp 

• Accounting Tools, “Days Sales Outstanding (DSO)”, https://www.accountingtools.com/articles/2017/5/15/days-sales-outstanding-dso

• Investopedia, “Accounts Receivable Turnover”, https://www.investopedia.com/terms/a/accounts-receivable-turnover-ratio.asp 

• Investopedia, “Debt Collection Period”, https://www.investopedia.com/terms/d/debt-collection-period.asp 

• Investopedia, “Current Ratio”, https://www.investopedia.com/terms/c/currentratio.asp