A small business needs cash to operate, and that cash often depends on your customers paying you in a timely manner. This is where the days of outstanding sales (DSO) formula comes in. Your company’s DSO value tells you the average number of days it takes to get paid for a sale on credit. In this article, we explain how to calculate DSO and why it’s important for your small business.
What is Days of Sale Overdue (DSO)?
Days in Sales is a financial ratio that tells you how long it takes your business to get paid for a sale, on average. This is also known as debit days and average collection time.
Calculate your open sales ratio by dividing your average accounts receivable during a given period by your total credit sales during the same period, then multiplying this answer by the number of days. The current sales pipeline formula is part of the cash conversion cycle. You can view a company’s DSO monthly, quarterly, or annually.
Understand days of outstanding sales
Your small business’s average DSO shows how long it takes you to collect payment for credit card sales over time. Cash sales are not taken into account in the calculation of the DSO since you are paid for them in advance.
A lower DSO is a positive sign that you get paid quickly and can add it to your working capital sooner. A higher DSO, on the other hand, means your customers are taking longer to pay you. If a DSO ratio continues to climb over time, it could cause serious cash flow problems for your business.
Why is the DSO important?
Using the DSO formula can give you a more accurate picture of the overall financial health of your small business. Your business cash flow is essential to the smooth running of your business. The financial principle known as the time value of money means that the money you have today is worth more than the money you will get in the future.
Calculating your DSO value helps you determine:
- How long does it take you on average to get paid
- How many sales did you make during a period of time
- If there are any issues with the way you collect payments
- The potential for future cash flow problems where you struggle to pay your bills
- If you need to weed out one of your customers because the collection process is a struggle
So, having a low DSO value is essential for a successful business because it means you get paid faster, and a high DSO means the opposite.
What DSO means for your business
If you are a new business or a business without excessive cash flow, tracking your DSO can prevent you from jeopardizing your business results. A rising DSO means your customers are taking longer to pay. This could be because your sales team is offering products to customers with bad credit or encouraging customers with longer payment terms. It could also mean that your customers are less satisfied with your service.
If the trend is down, it means the opposite: your customers are paying quickly and you have more money to grow your business. And if it varies, that might not be a problem if your business is seasonal and the variations are similar from year to year. But if your business isn’t seasonal, it’s worth looking at a variable DSO to see if there are any issues you can fix.
Good and Bad DSO Numbers
A DSO of less than 45 days is great – it means your customers pay you within an average of 45 days. But a good DSO versus a bad DSO depends on your industry. Industries like finance have longer payment terms than agriculture, for example, and will affect different types of businesses in different ways.
If your DSO is higher than you would like, there are several things you can try:
- Ask your customers to pay upfront. You might be surprised that many customers are willing to pay immediately. Advance payments can help reduce your DSO.
- Incorporate easy payment methods. Your customers are also busy, so make sure it’s not a multi-step process to get paid. Consider offering online payments to make things easier.
- Review your credit policy. You may want to be more careful who you offer credit to. Checking your customer’s credit rating can give you a good idea of whether or not they are late on payment.
Example of GRD
Let’s look at two example DSOs for a fictional company, Company ABC, so that you better understand how to calculate the DSO. You can find these numbers by looking at the company’s financial statements.
The formula for DSO is:
Average accounts receivable balance during the period ÷ total value of credit sales during the period x number of days
During the month of March, ABC Company makes $25,000 in credit sales and $10,000 in accounts receivable. To find the DSO for the 31 days of March, the equation would look like this:
$10,000 ÷ $25,000 x 31 = 12.4
So, the DSO value for ABC Company in March is excellent at 12.4. This means it took less than 13 days to get paid in March.
When to use DSO and when not to use it
You don’t want to use DSO alone. Instead, use the calculation along with other accounting metrics like turnover rate to give you a more complete picture of your company’s performance.
You will also want to track DSO over time. If you look at the number each month, it will give you a good real-time idea if your payments are late and your collections process is working. You can then use this information to make adjustments or improvements to get your money faster.
However, a business that uses credit for most or very little of its sales would likely not benefit from calculating its DSO value – it does not represent the true cash flow of the business.
How do you calculate the DSO?
The DSO equation divides the average accounts receivable during the period by the total value of credit sales during the period. Then multiply the result by the number of days in the period.
What is a good DSO ratio?
A good DSO value is below 45 because it means it takes your customers less than 45 days on average to pay you. However, the exact definition of a good DSO depends on the industry you operate in, as prompt payment is more vital for some industries than others.
How do you calculate the DSO for three months?
If you want to look at a three-month DSO, add up the number of days in those months. For example, if you look at the end of the year, October has 31 days, November has 30 days, and December has 31 days. This is a total of 92 days, which you will enter into the formula for the number of days.
A lasting solution to cash flow problems
We know that not having enough money for your business can keep you up at night. If you’re having cash flow issues caused by high DSO (or that wouldn’t be resolved if your customers paid faster), Nav is here to help. There are many financing options you may qualify for, such as small business loans or credit cards. Create your free Nav account to see what options are available for your business.
Rate this article