Definition of DSO
Days Sales Outstanding (DSO) measures the average time it takes a business to get payment from a client after a transaction.
Business owners can also view DSO as the time it takes for credit sales to be converted to cash or as the time it takes for receivables to be collected.
How to calculate Days Sales Outstanding with the DSO formula
You can calculate your Days Sales Outstanding (DSO) using this simple formula:
DSO= (Net Credit Sales/Accounts Receivable)x No. Of Days
Let’s understand the above with the help of an example:
As a small business owner, Max sells his goods and collects customer payments within 30 days of each sale. This prompt payment policy helps him keep the cash flow moving and ensures that he can cover his costs and continue to grow his business.
Although the majority of clients pay on time, some frequently miss payments. Max is trying to determine how effective the accounts receivable process is.
His yearly financial accounts look like this:
- Accounts Receivable: Rs. 50,000
- Net Credit Sales: Rs. 550,000
DSO = (50,000/550,000) * 365 = ~ 33.18
Cash sales transactions are typically excluded from the DSO calculation formula because it only accounts for credit sales.
Divide your final accounts receivable by the total credit sales for the period (monthly, quarterly, or annually), multiply the result by the number of days in the period, and you’ll have your answer.
How does DSO impact your business?
DSO is a helpful indicator that you can use to assess several essential business aspects, including how soon your customers pay you, your firm’s liquidity, the volume of sales you generate over time, the effectiveness of your sales staff, customer satisfaction, and client retention.
There is no one size fits for the DSO number; it depends on your company size. For instance, a DSO of 45 days might not be an issue for a significant company, but it is dreadful for a small company.
You can use that information to improve your business practices by regularly tracking your DSO trends. To get the most accurate results, it’s best to measure your DSO periodically instead of basing changes on individual DSO results.
3 Ways to reduce DSO
There are several ways to reduce DSO, which are:
- Offering incentives for prompt payment
Offering incentives for early payments accelerate the payment process, as discounts and early-bird offers are well-received by customers. Ensure that your invoices contain the late fee terms and conditions so that the customers know about them upfront.
- Improving customer communication and collections processes
When you offer recurring services, auto-charging is usually the best option. Storing your customers’ credit card details means you can charge them automatically on the due date, which makes things much easier for you. All you have to do is inform your customers about this policy when you set up the system. You should also notify them before and after you charge them.
- Invest in online billing software
Your procedure for collecting payments needs to be planned out and precise. You might achieve that by investing in the online billing software. You can promptly charge your clients as soon as a sale is made. And online billing software can help you do that.
Why are Days Sales Outstandingly Important?
The Days Sales Outstanding figure is vital because it provides insight into how quickly a company collects its receivables.
Is a higher or lower days sales outstanding better?
A high DSO means that a company's customers are taking longer to pay their invoices, which could indicate financial difficulties. Conversely, a low DSO means that a company is collecting its receivables quickly, which is a good sign of financial health.
What do Day sales outstanding means?
Days Sales Outstanding (DSO) measures a company's average receivables during a specific period, usually one month.
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