Knowing your Days Sales Outstanding or ‘DSO’ number can be a real help when it comes to managing expectation around payment times and the effectiveness of your cash collection.
64% of invoices are paid late according to recent research by Xero online accounting, and that late payment can have a significant impact on your organisation’s financial health. Slow payment = higher aged debt, poor cashflow, lack of investment and possible financial worries.
So how does knowing your company’s DSO help you get proactive with payment times?
What does DSO mean in terms of payment times?
Days Sales Outstanding (DSO) is an estimate of the number of days it takes a company or organisation to collect its outstanding accounts receivable – in the most simple terms, it’s a measure of how long it takes your customers to pay an invoice.
This DSO number is generally calculated on a monthly, quarterly or yearly basis, and is used to compare your company’s collection policy and performance against the industry standard for other businesses in your specific sector.
So what does this DSO figure tell you?
- High DSO – a high DSO implies your collection policy is too liberal, that you’re slow in collecting payment from customers and that opportunities for investing sales revenues back into the business are being missed.
- Low DSO – alternatively, a low DSO tells you that your collection policy is too strict, something that could affect your customer relationships and deter customers from returning for potential repeat business and sales.
DSO as a periodic measurement of payment times
DSO is generally measured as a periodic parameter. In other words, DSO will usually be calculated once the period in question has been completed (although other methods are available). To know the company’s DSO using the periodic approach, you must reach the end of that period, and then calculate your outstanding invoices across that month.
For example, your DSO won’t change between 1st-27th of February as you haven’t yet reached 28th February and completed the month.
It’s important to bear this periodic nature in mind, and to only calculate the DSO once you’ve reached the end of your chosen period.
How to calculate DSO
There are many different DSO calculation methods but we’re going to use the countback method. The countback method is the most conventional approach for monthly calculations.
To calculate your DSO there are some key steps to the process, which we’ll outline for you here:
- Calculate your open ledger – start by calculating the outstanding accounts receivable figure (open_ledger) at the end of the period. Let’s assume we’re looking for January 2018’s DSO, so your period end date will be 31-01-2018. To find the balance of each invoice we need to account for partial payments and credit notes applied to invoices up until 31-01-2018. By doing this we can see what our accounts receivable balance looked like at the end of the January period.
- Calculate your gross sales – next, we calculate the total amount of sales for the period (gross_sales). This is done by calculating the total amount of all receivable invoices between 01-01-2018 and 31-01-2018.
- Compare your open ledger to gross sales – We now have have two figures – our ‘open ledger’ number and our ‘gross sales’ number. To continue the calculation, we must compare these two variables. If your open ledger figure is larger than your gross sales, DSO is increased by the number of days in the period – it’s that simple. The open ledger number is then reduced by your gross sales figure. Note that the starting value of DSO is zero when beginning your calculation.
- Counting back for prior periods – Having calculated the figure for our first period, we then need to ‘count back’ for the preceding periods. To do this, steps 2 and 3 are repeated for the preceding periods (i.e. for the December and November periods), checking that your open ledger is bigger than your gross sales number.
- Apply the countback method formula – if your gross sales figure becomes larger than the open ledger number, DSO is increased by taking the ratio of the open ledger and gross sales numbers and multiplying this by the number of days in that period, i.e:
Where N is the number of days in that period.
This will all make sense as a process once we put this into practice in the following example.
How this works in practice
To get the DSO number for your chosen period, you need to work through the steps we’ve outlined above. So how does this work in practice?
Here’s an example of a DSO calculation for the month of January:
|January (31 Days)||£5,000||£13,000||31|
|December (31 Days)||£3,000||£8,000||62|
|November (30 Days)||£10,000||£5,000||77|
In the example ledger above, the balance of the outstanding open ledger at the end of January is £13,000. To calculate our DSO number we need to find the gross sales for January. In our example ledger, this is £5,000, so our open ledger figure is reduced by £5,000 and DSO is increased by 31 days – pretty straightforward once you know the methodology.
Next, we move back in time by one period to December. This month’s gross sales amount to £3,000. As the open ledger is larger than £3,000 we add the whole period to the DSO (31 to 62) and reduce the open ledger by £3,000.
Finally, the gross sales number for November is larger than the remaining open ledger. So our DSO is increased by 15 days, giving us a final DSO number of 77.
This formula for this final contribution looks like this:
We’ve also made a few assumptions in order to complete the calculation:
- An invoice with multiple payments is not counted as one lump sum. Instead, the payments are allocated into their respective month for the DSO calculation.
- Credit notes and overpayments don’t apply to DSO unless they’re allocated to an invoice
- DSO is calculated in the organisation’s base currency
Being proactive with improving late payment
Armed with an up-to-date DSO number, you can review your collection policy and start getting proactive about reducing late payment times, or getting your policy more in tune with customer’s needs around payment terms.
This is all much easier to do when you have a smart credit control and cashflow solution to help you. Fluidly makes it simple to find your open ledger and gross sales numbers and to closely monitor your DSO over time.