Table of contentsWhat is days sales outstanding? The DSO meaningHow to calculate DSO? Understanding the days sales outstanding formulaThe purpose of DSO: Why should we calculate DSO?
With this DSO calculator (Days Sales Outstanding) you can easily calculate how long it takes for a company to collect money from its customers. Days sale outstanding is a very effective metric when analyzing the effectiveness of a company.
This article will help you to understand the following topics:
- What is DSO in finance, which stands for days sales outstanding;
- How to calculate DSO; and
- How to apply the DSO formula in real life.
Moreover, we will also show you some calculation examples so that you will be able to analyze companies by using the days sales outstanding formula. But, before diving into examples, let's make sure we understand what DSO in finance is.
What is days sales outstanding? The DSO meaning
Days sales outstanding, or DSO, is a measure of how quickly a company can collect its money from its customers. The number represents the average time it will take for the company to collect its credit from all of its buyers or customers.
The speed at which a company can collect its money plays a huge part in its operation. In particular, it can tell us how effective the company is managing its working capital. Now, let's look at some examples of how to calculate days sales outstanding.
How to calculate DSO? Understanding the days sales outstanding formula
To understand the DSO meaning, let's use a hypothetical company — Company Alpha — as an example.
Company Alpha reports the following information:
- Accounts receivables in 2020: $300,000;
- Accounts receivables in 2021: $250,000; and
- Sales in 2021: $5,000,000.
The DSO calculation is not difficult at all - it only requires 4 steps:
- Calculate the average accounts receivables
Accounts receivable represents the amount of money owed to the company in question, which is Company Alpha in our example. The
average accounts receivablescan be derived by using the following formula:
average accounts receivable = (beginning accounts receivable + ending accounts receivable) / 2
In our example, the
average account receivablesfor Company Alpha equals
($300,000 + $250,000) / 2 = $275,000.
- Determine the sales figure of the company
The sales figure of the company is technically the revenue of the company. The easiest way of finding this value is to read the company's annual report. The sales figure of a company will always be reported in the company's income statement.
In our example,
sales = $5,000,000.
- Days in the company's accounting period
The accounting period of a company is essentially its fiscal year, which more often than not has 365 days. Hence, we can safely assume that
days in the company's accounting periodis
- Calculate days sales outstanding using the DSO formula
Now that we have all the inputs required, it is time for us to calculate the DSO of Company Alpha. We can do this by using the DSO formula:
DSO = (average accounts receivable / sales) * days in accounting period
With this formula, the DSO of Company Alpha can be calculated as
($275,000 / $5,000,000) * 365 = 20.075 days.
The purpose of DSO: Why should we calculate DSO?
After understanding what days sales outstanding is, we can now move on and explore the purpose of calculating DSO.
- DSO helps analyze a company's operation effectiveness
Working capital is an essential metric when analyzing a company's operational effectiveness. Companies with high DSO, when compared to their peers, tell us that they take longer than average to receive money from their customers. This might tell us that the company has problems with its collection and that something needs to be done about it.
- DSO helps us to identify bad debts in companies
If a company has a drastically higher DSO when compared to its peer, it may be helpful to start considering if we should classify those accounts receivable as bad debts. Bad debts are money owed by customers that are very unlikely to be collected by the company. Having high bad debts will heavily impact the company's future performance, so you might want to look out for them.
- High DSO can be detrimental for small and medium enterprises
Although accounts receivables and working capital may constitute only a tiny amount of what a public company has on their balance sheet, they may be crucial for smaller companies. This is because smaller companies, especially small and medium enterprises (SMEs), often rely on their working capital to run their daily operation. Hence, having a high DSO might be detrimental for SMEs and might even cause them to go bankrupt.
Lastly, it is worth noting that DSO only portrays one side of the picture. In order to fully understand the operation of a company, it is recommended to look at other activity ratios, such as days payable outstanding (DPO), days inventory outstanding (DIO), and the cash conversion cycle, to get a full understanding of a company's operation.
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