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Problem With Days Sales Outstanding Example

See also:
Daily Sales Outstanding Calculation
Operating Cycle Definition
Unlock Cash in Your Business
Turnover in Collections is Destroying Your DSO
Daily Sales Outstanding (DSO)

Dales Sales Outstanding Explanation

Often days sales outstanding (commonly referred to simply as DSO) is used as a measure of the average number of days it takes for a company to collect on its credit sales, using the accounts receivable balance at the end of a period and the amount of credit sales for that period. Days sales outstanding is closely related to accounts receivable turnover, as DSO can also be expressed as the number of days in a period divided by the accounts receivable turnover. The lower the DSO, the shorter the time it takes for a company to collect. Whereas a higher DSO means a longer time period to collect and usually indicates a problem with a company’s collection process and/or credit underwriting.


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How To Use Days Sales Outstanding

Days sales outstanding is a measure which should be monitored often in order to gauge the efficiency and effectiveness of a company’s accounting department. Closely examine the trend in DSO over a period of weeks or months to identify problems. This is especially true before they get out of hand. As a result, comparing the Days Sales Outstanding industry average with that of the company will help to gauge whether or not a company is lagging or surpassing its competitors in its accounting operations. One way to monitor trends in days sales outstanding is through the use of a flash report. For example, a company may also consider implementing a daily cash report to manage its cash on a daily basis, with an eye towards improving its DSO by improving its collections.

It is important to understand the days sales outstanding formula and what assumptions are made in its calculation. The following days sales outstanding example highlights a common problem.

Problem With Days Sales Outstanding Example

Unfortunately, the conventional methodology for calculating days sales outstanding weighs heavily on a company’s average annual sales, or a running 12 month average. Consequently, this approach overlooks the impact seasonality of sales can have on that statistic and can sometimes provide a misleading picture of the status of accounts receivable.

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Let’s assume two situations with the following facts:

Annual sales: $36,000,000 (or $100,000 per day)

Company A

A/R balance at end of current month: $7,000,000

Sales
Current Month: $6,000,000
1 Month Ago: $5,000,000
2 Months Ago: $2,000,000

Company B

A/R balance at end of current month: $7,000,000

Sales
Current Month: $2,000,000
1 Month Ago: $2,000,000
2 Months Ago: $1,000,000
3 Months Ago: $2,000,000

DSO Calculation

To calculate the traditional DSO for both companies, divide $7,000,000 by the average daily sales for the last 12 months of $100,000. This returns a DSO of 70 days.

However, Company A’s receivables are in much better condition as they only have receivables equal to the last 36 days sales (calculated as (A/R balance/current month’s sales)*# of days in month, or
($7,000,000/$6,000,000)*30 = 35).

Meanwhile, Company B’s receivables represent sales from the past 108 days.

So for Company A, assuming the traditional DSO measure of 70 would overstate the time it would take to collect sales from the last month by two times. Comparatively, Company B would be understated by 38 days.

The Problem With Days Sales Outstanding

Although this example is an exaggeration of extremes, the traditional DSO methodology falls short when you consider seasonality trends. A high DSO usually indicates inefficiencies and problems in a company which are costing a company dearly. It is important not to just mechanically compute financial ratios such as days sales outstanding. But it also important to take a look at the numbers underlying your calculations to ensure that you have an accurate picture of a company’s performance. For more ways to improve your cash flow, download the free 25 Ways to Improve Cash Flow whitepaper.

Problem With Days Sales Outstanding Example

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Problem With Days Sales Outstanding

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Daily Sales Outstanding Formula

See Also:
Daily Sales Outstanding (DSO)
Daily Sales Outstanding Calculation
Problem With Days Sales Outstanding Example
CEI vs DSO
Days Inventory Outstanding
Operating Cycle Analysis
Days Payable Outstanding
Unlock Cash in Your Business

Daily Sales Outstanding Formula

The DSO formula is the basic way to calculate daily sales outstanding. In application a very valuable performance indicator becomes evident. Use the following DSO formula below:

Daily Sales Outstanding = 365 X (Average Accounts Receivable / Total Credit Sales)

The formula is derived from an understanding that a company’s success is measured by returns. More specifically, it refers to the notion that the more receivables are collected, the better off a company is faring. The “365” refers to the number of days contained in the recording period. If you calculate an overall estimate of Daily Sales Outstanding for the year, utilize 365 as an appropriate figure; representing the 365 days in the year.

Accounts Receivable Explanation

The average accounts receivable is fairly straight forward. This figure represents the overall amount that a company is owed. As the receivables goes up, that means that the company is making more sales overall. More clients owe the company money and therefore the net worth is increasing. At the same time, however, if receivables continues to increase, that means that the company has money that it has not collected yet (outstanding dues). The final important aspect of this formula is the total number of sales. The total number of credit sales refers to the total number of sales made as a whole. It makes sense for this number to be the denominator of this formula because of the fact that the total number of sales acts as a success indicator as a whole.

DSO & Accounts Receivable

At the end of the day, as the Daily Sales Outstanding formula yields lower figures, the organization continues to collect the money owed to them. This is what makes the recording period so important. When introducing the number of days in the recording period into the equation, translate the overall success of the company into the timeline of the collecting period. Using the Daily Sales Outstanding formula, the company can determine the outstanding balance of returns that they are owed on a daily basis.

Additionally, you can compute the Daily Sales Outstanding formula in two very similar ways. The first method is the one that is listed above, using the average accounts receivable. The other method takes the overall accounts receivable instead of the average. Many companies use the average accounts receivable because it gives a more accurate picture of the company’s performance.

If you want to reduce your DSO, download our free A/R Checklist to see how simple changes in your A/R process can free up a significant amount of cash.

daily sales outstanding formula

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Daily Sales Outstanding Calculation

See Also:
DSO – Daily Sales Outstanding
Daily Sales Outstanding Formula

Daily Sales Outstanding Calculation

The daily sales outstanding calculation requires little more than a basic understanding of mathematics. Maintaining proper financials allows this and other essential calculations to be performed. The days sales outstanding formula, ultimately, leads to monitoring the health and wealth of your business. As a whole, perform the calculation of Daily Sales Outstanding using different periods of time as the overall indicator. Whether it be by years, months, or days, the organization as a whole needs to decide which method of time is the most appropriate for successful figures and for impressions. This is important because the different time periods can portray different results in cash flows and statistical models.

Calculating Daily Outstanding Sales is fairly simple, as said before. First, divide the total (or average depending on if you need actual or average days) accounts receivable balance by the total credit sales. Then multiply this remaining number by the total number of days or months in the time period. This also depends upon whether you desire average or total days. See the following example below.

Example of Daily Sales Outstanding Calculation

For example, assume Total Credit Sales are $1,000,000 and Average Accounts Receivable is $100,000.

(DSO) Days Sales Outstanding Calculation: 365 X (100,000 / 1,000,000) = 36.5 days

This is a simplified explanation of how to calculate daily sales outstanding. What the days represent is essentially the average number of days that are needed in order to collect the total accounts receivable balance from clients. A trained CFO can provide more extensive analysis and solutions. At the same time, it would not be overly difficult to produce the same quality work as a trained CFO.

After you complete the calculation, match the figures against the competition in the industry. Then determine the overall health of the organization. As far as the final figures go, calculating the Daily Outstanding Sales can tell you a couple of things about the state of your business. If the credit sales are substantially higher than is customary, then your services are being handed out much like a loan. The customers are purchasing this service without paying. A consequence of this could be a negative effect on a company’s cash flows so extensive credit sales should be avoided without collection.

Download the A/R Checklist to see how simple changes in your A/R process can free up a significant amount of cash.

daily sales outstanding calculation

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Daily Sales Outstanding (DSO)

See also:
Daily Sales Outstanding Formula
Daily Sales Outstanding Calculation
Accounts Receivable Turnover Analysis
Credit Sales
Financial Ratios

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.

For more tips on how to optimize your accounts receivable, download your free A/R Checklist here.

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.

Calculating DSO

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.

daily sales outstanding

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Access your Cash Flow Tune-Up Tool Execution Plan in SCFO Lab. The step-by-step plan to get ahead of your cash flow.

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Resources

For statistical information about industry financial ratios, please go to the following websites: www.bizstats.com and www.valueline.com.

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