Days Sales Outstanding (DSO) | Definition, calculation and importance

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    Credit control & accounts receivables

    Days Sales Outstanding (DSO) | Definition, calculation and importance

    In the world of business, it's essential to know where your company is at financially.

    One metric you may come across is Days Sales Outstanding (DSO). This measures how long it takes a company to collect payments on its outstanding sales.

    In this blog post, we'll explain what DSO is, how to calculate it, and why it matters. We'll also provide tips on how to reduce your DSO and improve your cash flow!


    What does DSO mean?


    DSO means "Days Sales Outstanding". It's a metric that measures how long it takes a company to collect payments on its outstanding sales.

    To calculate DSO, you divide the number of days in a period by the number of invoices that were issued during that period.

    The period can be any length of time, but is typically one month.

    For example, let's say your company had 100 invoices in January, and it took an average of 30 days to collect payments on those invoices.

    That means your DSO for January would be 30 days (100 invoices / 30 days = 30).


    Why does DSO matter?


    DSO is important because it's a good indicator of a company's financial health.

    A high DSO means it's taking a long time to collect payments, which can put a strain on the company's cash flow.

    On the other hand, a low DSO means the company is collecting payments quickly, which is a good sign of financial health. DSO can also be a good indicator of how well a company is doing at extending credit to customers.

    For example, if a company has a high DSO, it may be because it's extending too much credit to customers who are having difficulty paying their bills.

    Conversely, if a company has a low DSO, it may be because it's not extending enough credit to customers.

    Extending too much or too little credit can both have negative consequences for a company, so it's important to strike a balance.

    That's why DSO is such an important metric for businesses to track.


    What is the formula for Days Sales Outstanding?



    DSO is calculated by dividing a company's accounts receivable by its average daily sales:

    Days Sales Outstanding = (Accounts Receivable/Net Credit Sales)x Number of days

    For example, let's say that a company has $100,000 in accounts receivable and it makes $500,000 in sales per day.

    That company's DSO would be 100,000/500,000, or 20 days.

    Let's look at a more complex example.

    Company ABC has the following receivables and sales for June:

    Receivables on June 30th: $100,000
    Sales for the month of June: $500,000
    Average daily sales for the month of June: 500,000/30 days in June = $16,667 per day
    DSO calculation: 100,000/16,667 = approximately six days

    As you can see from this example, DSO is a relatively simple metric to calculate.


    What is a good Days Sales Outstanding?


    There is no definitive answer to this question, as it varies from industry to industry.

    However, as a general rule of thumb, a DSO of 45 days or less is considered to be good. This is because it indicates that the company is collecting its receivables relatively quickly.

    A DSO of 45 days or more is considered to be poor, as it indicates that the company is taking too long to collect its receivables. This can put a strain on the company's cash flow and make it difficult to pay its own bills on time.


    Why is reducing Days Sales Outstanding important?


    There are a few reasons why reducing DSO is important:


    It can improve cash flow

    The sooner you receive payment for a sale, the sooner you have cash available to reinvest in your business. Can flow is crucial for businesses, as it allows them to pay their own bills on time and avoid taking out loans.


    Reducing DSO can improve relationships with customers

    If you're constantly chasing customers for payment, it's not going to do wonders for your relationship with them. In fact, they may start to view you as a nuisance rather than a valuable supplier.


    It can improve your business's credit score

    Your DSO is one of the factors that creditors will look at when considering whether to extend credit to your business. A high DSO could make them think twice about lending you money, whereas a low DSO could give them the confidence they need to lend you the money you need.


    It can help you manage your cash flow more effectively

    If you know how much money you're likely to have coming in each month, it makes it a lot easier to manage your outgoings and make sure you don't run into any cash flow problems.


    It can give you an insight into your business's financial health

    Your DSO is a good indicator of how quickly your customers are paying their invoices. If it's high, it could be a sign that there are problems with your credit control procedures or that your customers are finding it difficult to pay their bills.

    As you can see, there are a number of reasons why measuring your DSO is important. It's not just a number that you should calculate and then forget about. It's something that you should keep an eye on and try to improve where possible.


    How does DSO impact your business?


    There are a number of ways in which DSO can impact your business, both positively and negatively:

    Positively:

    A lower DSO means that you're getting paid quicker and, as a result, have more working capital available to invest back into your business. This can help you to grow faster and be more profitable.

    A lower DSO can also help improve your relationships with your suppliers as they'll see that you're good at paying your bills on time. This could lead to them giving you better terms in the future or offering early payment discounts.

    Negatively:

    A high DSO can put a strain on your cash flow and make it difficult to meet other financial obligations. This can quickly snowball into bigger problems if not managed properly.

    A high DSO can also damage your relationships with suppliers as they may see you as a high-risk customer. This could lead to them charging you more for goods and services or even refusing to do business with you altogether.


    How to reduce your DSO


    There are a few things you can do to reduce your DSO and improve your cash flow:

    • Review your credit terms with customers and shorten them if possible - Credit terms are the number of days that a customer has to pay their invoices. By reducing your credit terms, you can reduce your DSO.

    • Invest in technology to automate invoicing, and collections - Automated credit control platforms like Chaser can help you to keep on top of payments and chase late invoices automatically by sending polite emails and SMS reminders on your behalf. This can free up time for you and your team so that you can focus on other areas of the business.

    • Outsource your credit control function - This can free up time for you and your team to focus on other areas of the business, plus you can benefit from the expertise of professional credit controllers. Chaser's outsourced credit control services are significantly more cost-effective than in-house teams while offering a flexible and proactive service.

    • Carry out regular credit checks on new and existing customers - Credit checking new customers will help you to avoid doing business with companies that are at high risk of defaulting on payment.

    • Offer discounts for early payment - This can incentivise customers to pay their invoices sooner and help to improve your cash flow.

    • Put a policy in place for late-paying customers - This could involve charging interest on late payments or suspending credit facilities. By having a policy in place, you can enforce it consistently and fairly.


    At the end of the day, reducing your DSO is all about improving your cash flow. By taking some or all of the above steps, you can get paid faster and have more working capital available to keep your business running smoothly.


    A vital business metric


    DSO is an important metric for businesses to track as it can have a big impact on cash flow and profitability. While there's no magic number that all businesses should aim for, reducing your DSO can have many positive benefits.

    If your DSO is high, take steps to bring it down by improving your invoicing and collections processes. To find out more about how Chaser can help you get paid faster, book a demo or start your free trial today!

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