What Is Days Sales Outstanding (DSO)?

Managing cash flow is critical to keeping your business healthy, but it's easier said than done. To keep your cash flow strong, you have to manage inventory purchases, collections processes of accounts receivable, and accounts payable, among other factors.

Staying on top of all these details can be overwhelming, especially when one misstep can threaten your business' stability. You need to know what's going on in your business financially at any given point so you don't end up short on cash and struggling to keep everything running.

That's where your days sales outstanding comes into play.

Days sales outstanding (DSO) plays a key role in managing cash flow. By tracking your DSO, you gain a deeper understanding of how money moves through your business. Learn how to calculate and manage DSO to protect your startup's financial health.

Days Sales Outstanding 101

When running your business, you must track many different financial ratios. One of them is the days sales outstanding ratio (DSO). Here are the ins and outs of DSO you need to know to utilize this metric effectively.  

Definition Of DSO

Days sales outstanding (DSO), also known as days to collect or days sales in accounts receivable, measures the average amount of time it takes your business to collect payment after making a sale.

A higher DSO indicates that it takes you longer to collect your outstanding invoices. A lower DSO tells you that you're collecting cash from your sales faster, which is preferable.

DSO is one component of the larger cash conversion cycle (CCC) — the amount of time it takes your business to convert the money you spend on inventory into cash from sales. Lowering your DSO will also bring down your CCC.

Importance In Business Operations

Understanding your days sales outstanding is vital to successfully running your business operations. Your DSO tells you whether you're managing your receivables efficiently.

If your DSO value is too high, you know that your business is slow to convert credit sales to cash. This slower conversion can lead to liquidity and cash flow problems down the line.

Improve your DSO to have more cash on hand and minimize liquidity risk. Collecting your accounts receivable faster will make it easier to meet your financial obligations, reinvest in your business, and create a cash safety net for unexpected expenses.

How To Calculate It

Calculate your DSO by dividing your total accounts receivable over a given period by your net credit sales over the same time and multiplying by the number of days in that period. Ignore any cash sales for this calculation, as the DSO for these sales is automatically zero since you're collecting payment immediately.

Days sales outstanding = (accounts receivable / net credit sales) * number of days

Your accounts receivable is the total amount owed to your business for products or services already delivered to customers. Your net credit sales are the portion of your total revenue from customers paying on credit.

Find your accounts receivable figure on your balance sheet and your net credit sales under revenue on your financial statements.

Days Sales Outstanding Example

Say, for example, you have sales revenue of $1 million over 30 days, all credit sales. At the end of those 30 days, your accounts receivable are $400,000.

Days sales outstanding = ($400,000 / $1,000,000) * 30

By dividing the $400,000 accounts receivable by the $1 million net credit sales and multiplying by 30 days, you get a DSO of 12 days. In other words, it takes your company an average of 12 days to collect payment after making a sale.  

Gather Your Data

To calculate your DSO, you need accurate, up-to-date data about your credit sales and outstanding accounts receivable. Ensure the data you're using is from the same time period.

So, for example, if you want to calculate the DSO for June, you need the gross accounts receivable and credit sales starting June 1 and ending June 30. You also must use 30 days instead of 31. It's easy to accidentally include data from the preceding or subsequent month, but your DSO calculations will be off unless all your data comes from the same period.

Remember that the DSO formula uses revenue, not profit from credit sales. Switching revenue and profit data in your DSO calculations will give you the wrong DSO.

Use The Correct Formula

Make sure to select the right formula based on the time period you're examining:

• Monthly: DSO = (accounts receivable / net credit sales) * 30 or 31 days
• Quarterly: DSO = (accounts receivable / net credit sales) * 90 days
• Yearly: DSO = (accounts receivable / net credit sales) * 365 days

You'll get a misleading result if you input the right data into the wrong days sales outstanding formula.

For example, in the year over year formula for DSO, you need to multiply by 365 days to cover the whole period. Accidentally using fewer days in this formula will yield a deceptively low days sales outstanding figure.

Interpret The Result

Once you run your data through the correct formula, you should get a number between approximately 1 and 100. If your calculations yield a number much higher or lower than these figures, check everything over to make sure you didn't make a mistake.

The number you get tells you how long, on average, it takes your business to convert sales into cash. If you conduct only cash sales, your DSO will be zero. A DSO of 50, for example, tells you that it takes your customers 50 days on average to pay you after they complete a purchase.

Higher DSO numbers tell you your business is waiting longer to collect cash from your sales. Some possible reasons that your DSO is high include:

• Your customers often make late payments
• You offer overly generous payment terms
• Your collections process is ineffective or inefficient
• You offer credit terms to customers with poor credit standing

Importance For Cash Flow Management

Your DSO gives you insights into the current health of your receivable process and cash flow management.

If you're experiencing cash flow problems, calculating your DSO will help you understand why. A high DSO is a red flag that you're not collecting on your receivable balance fast enough, keeping your money tied up.

Every additional day you wait to receive payment amounts to money lost. If you had those payments in hand, the funds could earn value for your business and boost your cash flow.  

Benchmarks And Industry Standards

An acceptable DSO varies from business to business and industry to industry. Thirty days of outstanding sales might be long in one sector and very quick in another.

Engineering and construction businesses, for example, averaged a DSO of 100 days in 2021. The average DSO is much lower in other industries, like internet and catalog retail, which had a mean DSO of 21 days. Across all industries, the average DSO is 40.1 days.

Use the average DSO in your industry as a benchmark. If you're already below that figure, try to make continual improvements.

Track your monthly, quarterly, and annual DSOs and strive to bring down those figures each period. The more your business relies on steady cash flow, the more important it is to keep your DSO as low as possible.

Tools And Software For Managing It

Manually calculating and tracking your DSO can quickly become a headache. If you have to dig through lots of irrelevant or inaccurate data to get the right accounts receivable and net credit sales figures, managing your DSO will become a drain on your time.

Instead, rely on automated accounting and bookkeeping software to handle your DSO accounting. With this software, you can access all your key financial data from a single dashboard and view each financial metric in real time, including days sales outstanding.

All this up-to-date information about your financial operations will help you make better, more informed decisions. You'll know at a glance if your DSO spikes or if you're successfully improving it over time.  

Optimize Business Performance Through Effective Sales Management

Tracking and understanding your days sales outstanding is crucial to sales management.

A low DSO value indicates that your business collects payments promptly and has a strong cash flow. On the other hand, a high DSO value should alert you that you need to improve your collections process. You may need to automate more of your collection process, implement stricter payment terms, or change your credit assessment policies.

Staying on top of your DSO will help you immediately catch any potential cash flow issues. That way, you can address the issues before your cash flow suffers and hurts your business.

Consider using automated software to track your DSO over time. This can save you the time and effort involved in repeatedly hunting down data and calculating DSO by hand. Learn more about cash flow management and financial planning software here.