Unlocking the power of efficient cash flow management often lies in understanding and effectively utilizing key financial metrics. One such essential metric is Days Sales Outstanding (DSO). This simple yet powerful indicator reveals how quickly a business can collect its account receivables, shedding light on the effectiveness of its credit and collection procedures.
A good Days Sales Outstanding score can be a game-changer, but what does that entail? This article walks you through DSO and its calculation methods and provides context on what constitutes a good DSO score.
An Overview of DSO
Days Sales Outstanding is a financial ratio that shows the average number of days it takes for a company to collect payment after a sale has been made. It is often used to gauge the efficiency of a company’s credit and collection efforts, with a lower DSO indicating better performance.
Knowing a company’s Days Sales Outstanding is essential for making informed decisions about cash flow management and identifying areas for improvement in the credit and collection process. It is a benchmark for evaluating a company’s performance over time and against industry standards.
Explaining the Characteristics of a Good DSO Score
A Good Days Sales Outstanding score is typically considered 45 or less, but this rule isn’t without its exceptions and nuances. Several factors may influence what constitutes a favorable versus unfavorable score:
- Industry: Different industries have varying standards for what’s considered a good DSO score. For instance, a satisfactory score in the aerospace industry might be seen as subpar in the textile sector. Companies with substantial capital outlays shouldn’t be evaluated using the same criteria as those producing everyday goods or services.
- Company-specific standards: Your company’s payment terms—whether net 30, net 60, or something else—should serve as a benchmark for evaluating your Days Sales Outstanding.
- Competitive landscape: Consider the performance of your main competitors. Are they more effective in managing their receivables? How does your DSO score compare to theirs?
A survey conducted in 2016 found the median Days Sales Outstanding score for companies across 27 industries. Here are these findings:
- Aerospace and Defense: 66
- Airlines: 11
- Automotive Parts and Aftermarket: 47
- Beverages: 36
- Building Products: 40
- Chemicals: 54
- Computer Hardware and Peripherals: 60
- Consumer Durables: 48
- Containers and Packaging: 44
- Electronic Equipment, Instruments, and Components: 58
- Energy Services and Equipments: 81
- Engineering and Construction: 82
- Food: 27
- Food and Staples Retail: 6
- General and Specialty Retail: 7
- Household and Personal Care:40
- Industrial Conglomerates: 62
- Internet and Catalog Retail: 16
- Machinery: 57
- Metals and Mining: 32
- Office Equipment, Services, and Supplies: 48
- Oil and Gas: 42
- Pharmaceuticals: 68
- Semiconductors and Semiconductor Equipment: 52
- Telecommunications Equipment: 57
- Textiles, Apparel and Footwear: 36
- Utilities: 47
As you can see, some industries tend to have higher DSO scores due to the nature of their business and payment terms. It’s crucial to consider these variations when evaluating your own company’s DSO score. A good rule of thumb is to aim for a score lower than your industry average.
How to Calculate the DSO Score?
Understanding how to calculate your DSO requires knowledge about the three main calculation methods: Standard, Best Possible, and Delinquent. These different methods offer varied insights into your company’s cash flow management and can help you identify areas of improvement. Let’s delve into each of these methods.
Standard DSO
Standard Days Sales Outstanding provides an average of the days it takes for a company to convert its account receivables into cash. You can calculate it using the following formula:
Standard DSO = (Ending Total Receivables / Total Credit Sales) x No. of Days in Period
Where,
- ‘Ending Total Receivables’ refers to the total amount of money owed to the company by its customers at the end of the period.
- ‘Total Credit Sales’ is the total sales made on credit during the same period.
- The ‘Number of Days in the Period’ is typically 30, 60, or 90 days, depending on the company’s financial reporting frequency.
Best Possible DSO
Best Possible Days Sales Outstanding, often called the best-case scenario, provides the lowest potential number of days a company could theoretically achieve in converting credit sales to cash. The formula is:
Best Possible DSO = (Current Receivables / Total Credit Sales) x Number of Days
Where,
- ‘Current Receivables’ are not overdue and are still within the agreed payment terms.
This calculation method gives a benchmark for the best possible performance in collecting receivables.
Delinquent DSO
Delinquent DSO provides insight into the proportion of receivables that are overdue. In other words, it measures the average number of days that payments are late. The formula is:
Delinquent DSO = Standard DSO – Best Possible DSO
A high Delinquent DSO could indicate issues with credit management and collection processes within the company, thereby pointing towards areas of improvement.
By understanding and applying these three methods, you can comprehensively view your cash flow management efficacy. Always remember that a lower Days Sales Outstanding is preferable, as it indicates a shorter turnaround in converting credit sales to cash, enhancing your company’s liquidity position.
The Capabilities and Limitations of DSO
While Days Sales Outstanding is an extremely useful tool for evaluating the effectiveness of a company’s accounts receivable processes, it’s crucial to be aware of its capabilities and limitations. Understanding what DSO can and can’t do will help in making more informed and balanced business decisions.
What DSO Can Do
- Benchmarking: DSO is an excellent benchmarking tool. It allows a company to compare its performance with industry averages and competitors. If your Days Sales Outstanding is significantly higher than the industry average or your main competitors, it might be an indication that your credit policies need to be reviewed.
- Cash Flow Management: DSO helps in managing cash flow by providing a clear picture of how long it takes, on average, to collect payment after a sale is made. This can assist in forecasting cash inflows and making informed financial decisions.
- Credit and Collection Processes Evaluation: A high DSO can indicate inefficiencies in your credit and collection processes. It can prompt a review of these systems, leading to improved processes and shorter collection times.
What DSO Can’t Do
- Provide a Comprehensive Credit Picture: While DSO is a valuable tool, it can’t provide a comprehensive picture of a company’s credit situation. It should be used with other metrics such as aging of receivables, percentage of bad debts, and collection efficiency.
- Account for Seasonality: DSO doesn’t account for seasonality or fluctuations in business operations. If your business is seasonal, DSO can be misleading. It’s essential to look at Days Sales Outstanding trends over a period of time and not just a single point.
- Determine Profitability: DSO measures the time it takes for a company to turn its receivables into cash, not how profitable those sales are. High profitability doesn’t always correlate with a low DSO.
While DSO is a powerful tool for gauging the effectiveness of a company’s credit and collection processes, it’s essential to understand its limitations and use it as part of a broader set of financial metrics.
How ReliaBills Contribute to Good DSO?
One of the best ways to achieve a good DSO is to streamline your invoicing and payment processes. That’s why a reliable payment processing platform like ReliaBills can significantly impact your DSO. Here are a few ways in which ReliaBills contributes to maintaining a good DSO score:
- Automated Invoicing: ReliaBills offers automated invoicing that eliminates the risk of human error and ensures the timely delivery of invoices to customers. This helps in reducing payment delays and improving the Days Sales Outstanding.
- Online Payment Options: ReliaBills allows customers to make payments online through various payment methods, such as credit cards and e-checks. This convenience can lead to faster payments, thereby reducing the Days Sales Outstanding.
- Payment Reminders: With ReliaBills, you can set up automatic payment reminders for your customers, making it easier for them to remember and pay their invoices on time. This can significantly improve the Days Sales Outstanding.
ReliaBills can streamline your invoicing and payment processes, leading to faster payments and better DSO scores. Additionally, ReliaBills offers powerful reporting tools that allow you to track your DSO over time and identify areas of improvement in your cash flow management.
With ReliaBills, you have an all-in-one solution to your invoicing and payment processing needs. Our convenient solutions will enable you to focus more on running and growing your business. Get started today!
Wrapping Up
Understanding and effectively managing your Days Sales Outstanding is a critical aspect of maintaining a healthy cash flow and ensuring the financial stability of your business. While the ‘Ideal’ DSO may vary across industries, a lower DSO generally indicates a faster conversion of credit sales to cash, thereby enhancing your company’s liquidity.
However, DSO comes with its limitations and should be combined with other financial metrics for a comprehensive credit picture. Platforms like ReliaBills can offer automated invoicing and payment processing solutions, which help improve your Days Sales Outstanding and cash flow management.
By integrating such solutions and keeping a close eye on your Days Sales Outstanding, you can maintain a strong financial position and pave the way for continued growth and success in your business.
