Days Sales Outstanding: The Hidden Number That Could Be Slowing Your Cash Flow

In the field of business and finances, it is like they say, cash is king- one of the most important measurements that determine the cash flow is Days Sales Outstanding (DSO). So long as you are taking care of a startup, running an expanding SME, or assessing the corporate finances, learning about the nature of the day's sales outstanding, and its role in a company can be of value to the decision-making process and financial capabilities.

DSO is a financial ratio that reflects the speed at which a corporation takes payment of its clients following the sales made. Simply put, it also measures the number of days an average business takes to accumulate cash as a result of credit sales. Lower DSO means that the collections are efficient and the cash flow is relatively healthy and the high DSO can mean that the collection of the accounts receivables is not coming along, or that things are too easy-going as far as credit policy is concerned.

Understanding Days Sales Outstanding in Accounts Receivable

The essence of the day's sales outstanding is that it reflects the efficiencies in terms of the accounts receivable of a company. It will reveal the duration your customers undergo before they make payments to your business. In your case where you sell products or services on credit, DSO is the key to proper working capital management.

As an illustration, suppose that your DSO is 45 days, it will indicate that when you execute a sale on credit, you pay the product to the customer after 45 days. This ratio is especially important to the companies that have high amounts of its receivables, including B2B service providers, manufacturers, or subscription-based companies.

It may clog your cash cycle with a consistently high DSO that makes it hard to meet payroll, reinvest on growth or to cover your operation costs. That is why monitoring this measure is not actually the task of a finance team only as it influences your entire organization.

Days Sales Outstanding Formula and Step-by-Step Calculation

The calculation of Days Sales Outstanding (DSO) is easy. The formula to calculate the days sales outstanding is this:

DSO = (Accounts Receivable ÷ Total Credit Sales) × Number of Days

How about this really? Let us inspect:

• Accounts Receivable is due to your customers at a particular time.
  
  

• Total Credit Sales indicate a sale on credit (not cash), in a given period.
  
  

• Number of Days is usually 30 (monthly), 90 (quarterly) or 365 (yearly), depending on the period of the reporting.

Example:

Had your company had 150,000 dollars in accounts receivables at the end of the quarter and 450,000 dollars in credit sales done at the same time window, i.e. over the same 90-day period, the DSO would be:

DSO = (150,000 ÷ 450,000) × 90 = 30 days

That implies that your company receives an average of 30 days to collect. This is a good indicator with most industries.

Days Sales Outstanding Explained with Real Business Examples

To have a glimpse of what DSO can do in the real world, the example of a software company with a monthly billing model is given. With the DSO of 15 days, it indicates that customers are settling invoices fast, which can be explained by automated billing and appropriately managed follow-ups.

And compare that to a manufacturer holding a DSO of 75 days. This could be as a result of the complex invoicing procedures, long cycle of payment, or slow collection of customer payments. Although long payment terms are sometimes the norm within manufacturing, a DSO which is considerably above industry averages may be an indication of weak credit management or collection inefficiencies.

At that, in both cases DSO can be viewed as a mirror: showing either power or weakness in the operations.

How to Improve Days Sales Outstanding for Better Cash Flow

With just a slight improvement on your DSO, you will enhance the flow of Cash and provide room to breathe to the business. A couple of methods to improve Days Sales Outstanding for better Cash Flow are:

• Streamline your invoicing process: Invoice on time and spell out payment terms clearly.
  
  

• Automate reminders: Automate reminders and set reminders before, after due dates via accounting software.
  
  

• Evaluate customer creditworthiness: You do not want to grant credit to customers who have poor credit history.
  
  

• Offer early payment discounts: Provide discounts to customers who will pay earlier.
  
  

• Review payment terms: If you can negotiate it, consider the possibility to pay the clients in shorter cycles.
  
  

The achievement of a better DSO cannot be grasped within two days, however, it can be observed that with a regular effort in place businesses will attain a significant improvement in flexibility and liquidity.

Best Practices to Reduce Days Sales Outstanding

The DSO should be reduced with the help of a combination of the policy, technology and human control. The following are some of the best practices to reduce Days Sales Outstanding (DSO):

• Write down clear credit terms and ensure that your sales persons stick to them.
  
  

• Negotiate with your terms of payment to appear clear and simple since the beginning of the business interaction.
  
  

• Assimilate the collections follow-up as a daily addition to your list of operations and not only as a practice to be carried out when invoices are outstanding.
  
  

• Use cloud accounting software which incorporates invoicing, receivables and reminders.
  
  

• Teach your receiving staff the principles of customer relation management in collections- A good customer relationship sometimes comes hand in hand with a cordial, but firm approach, this usually brings about faster results.
  
  

Companies adhering to these best practices will be able to decrease their DSO, bad debts and have healthier books.

Why Days Sales Outstanding Matters in Business

In order to understand how important days sales outstanding (DSO) in business are, it is important to see the larger picture of what it entails. 

To begin with, the DSO is quite a good indication of how efficient your business is. It indicates to you whether or not the revenue you are receiving is real or being converted into capital. Second, investors, lenders, and analysts usually take DSO as one of the main indicators of financial health and liquidity. 

This aspect of DSO creeping up may be lumped with a domino effect wherein delayed cash flows may result in missed payments to suppliers, borrowing more, and limited expansions. Conversely, keeping a low DSO at all times supports a better management of working capital and even promotion of the valuation of your company.

Final Thoughts

To conclude, day sales outstanding is not merely the measure, but it provides the indication of how well your business can generate, manage, and collect funds. Listening to days sales outstanding in accounts receivable, learning how to calculate days sales outstanding, and putting means in place to minimize it will make sure your company remains fast and healthy in terms of finance.

Trying to refresh your financial knowledge or wishing to learn to manage your receivables better, sign up to the course on working capital management or accounts receivable optimization. The methods and instruments acquired during this type of training can be applied in real code to decrease DSO and enhance cash flow, one of the lifelines of a winning business.