What is Days Sales Outstanding (DSO) and Why Does It Matter for AR Teams
Positive cash flow is critical for organizations to be able to grow, invest, and pay off their obligations. Efficient collections within accounts receivable is foundational to these efforts. One of the ways a company can measure this efficiency is by using the days sales outstanding (DSO) metric.
What is DSO?
DSO, or days sales outstanding, is a metric that measures the average amount of time it takes for a company to collect payments from customers after a sale has been made. DSO is a critical metric for accounts receivable teams as it tells them how efficiently they are collecting payments from customers. This is mission-critical because it directly impacts cash flow and their ability to pay off obligations.
How can teams calculate DSO?
Before measuring DSO, you must first determine the specific period to measure. Common timelines include a month, quarter, or the entire fiscal year, depending on your requirements.
Once you have locked in a time frame for your calculation, it's time to gather the necessary data. In this case, you only need two main accounting values: the average value of accounts receivable and the average credit sales made during the same period.
Calculate the average value for accounts receivable by adding together the AR value at the beginning of the period and the AR value at the end of the period. Next, divide the sum by two. Now it’s time to calculate the average credit sales by dividing the total by the number of days in the given period. Finally, divide the average accounts receivable by the average credit sales. The resulting figure is your DSO metric and will tell you how long it takes for customers to pay on average.
The formula for this calculation is as follows:
DSO = (Average accounts receivable / Average daily credit sale) x Number of days in the period
Once you've calculated your DSO, we recommend comparing it to industry benchmarks and your company’s historical performance to assess the efficiency of your current collections strategy.
Do you want a high or low DSO?
While the ideal DSO will vary depending on industry and company, lower DSO numbers often indicate better cash flow and a healthier customer base. Generally speaking, teams also prefer a low DSO because it means that a company collects customer payments faster, leading to better-working capital management. Lastly, a low DSO often indicates a lower credit risk as customers that pay promptly are less likely to default.
How to improve DSO?
Companies and teams can improve their DSO by following these 4 best practices:
- Streamline invoicing and billing processes with an AR automation solution. Several software tools can automate and streamline accounts receivable processes like invoicing, payment tracking, and reminders that have historically been redundant, tedious tasks for AR staff.
- Implement clear credit and collection policies. Conducting better credit risk assessments helps ensure that you exclusively work with customers that have a good track record of paying their obligations quickly and consistently.
- Offer incentives for prompt payments. Consider offering discounts or other incentives to customers who pay faster. This helps encourage customers to prioritize your invoices in their payment cycles and increases the likelihood of faster payments.
- Strengthen your customer relationships. Improving your customer service can directly help your DSO. By providing customers with better service, you encourage them to pay faster.
Important Takeaways for DSO
In conclusion, DSO is a critical metric for accounts receivable teams as it is an effective way to measure the efficiency of collections activities and cash flow. Knowing how to calculate DSO allows you to understand your performance relative to industry benchmarks or past results.
Lower Your DSO with Centime
Centime is a game-changer for finance teams looking to lower their Days Sales Outstanding (DSO). Our comprehensive and efficient accounts receivable solution helps businesses automate key tasks, reduce human error, and speed up their collection times, to shorten their DSO. With Centime, finance teams can keep a close eye on their DSO and optimize their working capital to help their bottom line. Get control of your cash today.
