How to Calculate DSO – DSO stands for days sales outstanding, a financial ratio that measures how long it takes a company to collect cash from its customers after making a sale. DSO is an important indicator of a company’s cash flow efficiency and liquidity. A low DSO means that the company can quickly convert its sales into cash, while a high DSO means that the company has to wait longer to receive its payments.
In this article, we will explain how to calculate DSO, what factors affect it, and how to improve it.
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How to Calculate DSO
DSO can be calculated by dividing the average accounts receivable during a certain time period by the total net credit sales during the same period and then multiplying the result by the number of days in the period. The formula for DSO is:
DSO = (Average Accounts Receivable / Total Net Credit Sales) x Number of Days
For example, suppose a company has $100,000 of average accounts receivable and $500,000 of total net credit sales in a quarter (90 days). The DSO for this company is:
DSO = ($100,000 / $500,000) x 90 DSO = 0.2 x 90 DSO = 18 days
This means that on average, it takes 18 days for the company to collect cash from its customers after making a sale.
What Factors Affect DSO
DSO can vary depending on several factors, such as:
The industry and market conditions
Different industries and markets may have different norms and expectations for payment terms and credit policies. For example, some industries may have longer payment cycles than others due to contractual agreements or seasonal fluctuations. Some markets may have higher default or delinquency rates than others due to economic or political factors.
The company’s credit policy and collection practices
The company’s own credit policy and collection practices can influence how fast or slow it collects its receivables. For example, the company may offer discounts or incentives for early payments, or impose penalties or interest for late payments. The company may also have different methods and resources for contacting and following up with its customers.
The company’s customer mix and quality
The company’s customer mix and quality can also affect its DSO. For example, the company may have more or less customers who pay on credit versus cash. The company may also have more or fewer customers who are reliable or risky in terms of payment behavior.
How to Improve DSO
Improving DSO can help a company improve its cash flow and liquidity, as well as reduce its financing costs and risks. Some of the ways to improve DSO are:
Reviewing and updating the credit policy and collection practices
The company should review and update its credit policy and collection practices regularly to ensure that they are aligned with its business goals and market conditions. The company should also monitor and evaluate its credit performance and collection efficiency using metrics such as DSO, aging analysis, bad debt ratio, etc.
Offering incentives or discounts for early payments
The company can offer incentives or discounts for early payments to encourage its customers to pay faster. For example, the company can offer a 2% discount if the customer pays within 10 days instead of 30 days. However, the company should also consider the impact of such discounts on its profit margin and cash flow.
Imposing penalties or interest for late payments
The company can impose penalties or interest for late payments to discourage its customers from paying late. For example, the company can charge a 1% interest per month if the customer pays after 30 days. However, the company should also consider the impact of such penalties on its customer relationship and reputation.
Segmenting and prioritizing customers based on payment behavior
The company can segment and prioritize its customers based on their payment behavior and risk profile. For example, the company can assign different credit limits, payment terms, discounts, penalties, etc., to different customer segments based on their payment history, credit score, industry, location, etc. The company can also focus more on collecting from high-risk or overdue customers.
Automating and streamlining the invoicing and collection process
The company can automate and streamline its invoicing and collection process using software tools and systems that can help reduce errors, delays, disputes, and costs. For example, the company can use electronic invoicing and payment methods that can speed up the billing and receipt of payments. The company can also use automated reminders and notifications that can prompt customers to pay on time.
In conclusion, DSO is a financial ratio that measures how long it takes a company to collect cash from its customers after making a sale. DSO is an important indicator of a company’s cash flow efficiency and liquidity. A low DSO means that the company can quickly convert its sales into cash, while a high DSO means that the company has to wait longer to receive its payments.
DSO can be calculated by dividing the average accounts receivable during a certain time period by the total net credit sales during the same period and then multiplying the result by the number of days in the period. DSO can vary depending on several factors, such as the industry and market conditions, the company’s credit policy and collection practices, and the company’s customer mix and quality.
Improving DSO can help a company improve its cash flow and liquidity, as well as reduce its financing costs and risks. Some of the ways to improve DSO are reviewing and updating the credit policy and collection practices, offering incentives or discounts for early payments, imposing penalties or interest for late payments, segmenting and prioritizing customers based on payment behavior, and automating and streamlining the invoicing and collection process.
Frequently Asked Questions (F&Qs)
How do you calculate DSO days in Excel?
To calculate DSO days in Excel, you can use the following formula:
=DAYS(A2,B2)/365Where:
- A2 is the cell containing the date of the last invoice
- B2 is the cell containing the date of the last payment
For example, if the last invoice date is in cell A2 and the last payment date is in cell B2, the formula would be:
=DAYS(A2,B2)/365This formula would return the number of days it took the company to collect payment on the last invoice.
You can also use the following formula to calculate DSO days in Excel:
=AVERAGE(DAYS(A2:A,B2:B))/365Where:
- A2:A is a range of cells containing the date of the last invoice for each customer
- B2:B is a range of cells containing the date of the last payment for each customer
For example, if the date of the last invoice for each customer is in the range A2:A and the date of the last payment for each customer is in the range B2:B, the formula would be:
=AVERAGE(DAYS(A2:A,B2:B))/365This formula would return the average number of days it took the company to collect payment on all invoices.
How do you calculate DSO by month?
Here is an example of how to calculate DSO using the countback method:
Month | Accounts Receivable | Sales
-------|----------------|---------
January | $10,000 | $5,000
February | $8,000 | $4,000
March | $6,000 | $3,000
April | $4,000 | $2,000
May | $2,000 | $1,000In this example, the DSO is 4 months. This means that it takes, on average, 4 months for the company to collect payments on its sales.