Daily Sales Outstanding (DSO) Definition
Daily Sales Outstanding (DSO) is a useful formula to measure the average age of accounts receivable. As a management tool, it can be used to measure as well as motivate employee performance.
Though the number of days is useful, it is often the trend of that number that is most important. If the length of time is trending up then immediate action is often required.
Comparison to the industry average is an important benchmark for performance. If competitors in your industry are collecting in fewer number days then the potential for improvement is often present.
The calculation of Days Sales Outstanding (DSO) on a frequent basis is a powerful management technique. This can be accomplished through the accounting package or included as a key performance indicator (KPI) in the flash report. The formula can also be expressed through a days sales outstanding ratio.
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Daily Sales Outstanding Example
For example, Karen owns a interior design company called Designco. The company provides services to create a welcoming and professional office. Karen’s company is growing very quickly after she was highlighted in a local business magazine. This has forced her to sell and service clients at a level she had never experienced before. Over time some of her accounts receivable sat idly while she satisfied new customers. Though overworked, Karen has begun to settle into her place in the market. Her experience tells her that now is the time to align her business to deal with this new volume of interest. Upon evaluating her progress she noticed that some of her receivables sat in wait.
This has sparked her curiosity into what her daily sales outstanding ratio looks like. She asks her CPA “how is DSO calculated”? He provides her with this information:
Total Credit Sales $ 1,000,000
Average Accounts Receivable $ 100,000
Days Sales Outstanding Calculation: 365 X (100,000 / 1,000,000) = 36.5 days
Karen is not satisfied with this. Her CPA, an expert in all forms of managerial accounting, provides days sales outstanding analysis and some solutions to choose from.
With this Karen decides to use a factoring company to solve the problem. Her reasons are two-fold: she will be able to outsource her collections while instantly gaining the cash necessary to begin creating a more permanent solution. Karen does her due diligence, finds a responsible factoring company which will conduct operations with the same level of professionalism as she does, and sells her uncollected receivables. This provides both a long and short term solution.
Karen’s days sales outstanding example is very common. This proves a powerful message to monitor cash flow: it is one of the most common reasons why businesses fail.
Daily Sales Outstanding Meaning
Daily sales outstanding (DSO) is an acknowledgement of the importance of cash in business. Due to this, it is in the company’s best interest to collect due payments as quickly as possible. Through evaluation of DSO businesses can see the average amount of time before accounts receivable are collected, a measurement of a company’s ability to collect cash in waiting, and a metric useful to evaluate the performance of the collections department of a company.
In addition, this flow of cash aids in the Cash Cycle. The daily sales outstanding ratio steps further to provide the average amount of time sales stand uncollected as compared to total sales. DSO, daily sales outstanding, is often combined with other financial ratios to form the slew of combined evaluation tools. It is, overall, one of the most important factors which can lead to the success of a business. If a business does not know How to Collect Accounts Receivable, then there is no way for the DSO to go down.
For more ways to add value to your company, download your free A/R Checklist to see how simple changes in your A/R process can free up a significant amount of cash.
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