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If you’ve ever taken a management accounting course, you’re likely familiar with days sales outstanding (DSO). Essentially, it’s the average number of days it takes to collect payment after a sale. All else being equal, a smaller DSO is better than a larger one—it means you’re getting paid faster.
But how do you calculate this metric? And more importantly, what’s the point of measuring and tracking it in the first place?
In this guide, we’ll provide the answers to both of those questions. We’ll break down the DSO formula, walk you through a practical example, then dive into why DSO is so vital for managing cash flow.
How to calculate DSO
The components
Calculating DSO requires three main inputs:
- Accounts receivable (AR): This represents the total amount your customers owe for goods or services sold on credit. It’s a snapshot of your outstanding invoices at a given point in time. You can find this figure on your balance sheet.
- Net credit sales: This is the total value of sales made on credit during the measurement period, minus any returns or allowances. Make sure you exclude cash sales—those are collected immediately and don’t contribute to accounts receivable.
- Time period: The period over which you’re measuring DSO can vary depending on your business needs: monthly, quarterly, or annually. The time frame you select should align with your financial reporting and operational cycles.
The DSO formula
The formula for DSO is relatively straightforward:
DSO = (AR / Net credit sales) * Number of days in period
This calculation yields the average number of days it takes to convert credit sales into cash.
Example calculation
Let’s illustrate this with a practical example:
- Your business has $50,000 in accounts receivable at the end of a 90-day quarter.
- During that quarter, your company recorded $200,000 in credit sales.
Applying the formula:
DSO = (50,000 / 200,000) * 90 = 22.5 days
In this case, it takes your business an average of 22.5 days to collect payments from customers after a credit sale.
The importance of DSO
So, now you know how to calculate DSO at a high level. But why even bother tracking it in the first place?
The most effective finance teams recognize DSO as a powerful diagnostic tool—one that provides invaluable insights into their business’ financial health. The best-run businesses in the world keep this metric as low as possible. Costco Wholesale, for instance, manages to keep their DSO just over 4 days on nearly $3 billion of accounts receivable. This gives them an enormous advantage over their competitors—they can invest that freed-up cash in inventory, expansion, or other growth areas.
In short, if your business extends credit in any meaningful way, you need to have a handle on your DSO. Let’s delve into some of the reasons why this is the case.
Measuring performance over time
Do you really know how effective your collections process is? Is it getting better (or worse) over time? Staying the same? Regularly monitoring DSO gives you a clear answer. A steadily declining DSO is a great sign—it indicates that your AR process is becoming more efficient. On the flip side, a rising DSO may point to inefficiencies or alarming changes in customer payment behavior.
Industry benchmarking
What’s considered a “good” DSO? There’s not really an objective scale—it varies based on industry, company size, and clientele. A report from The Hackett Group found the average DSO across all industries to be around 40 days, but it’s a wide spectrum. An 80-day DSO for a construction company would be considered top-tier, while 80 days in vehicle sales would be near the bottom of the industry.
Ultimately, telling the whole story of DSO requires comparing it against both your own historical performance and relevant external benchmarks.
Better project cash flow
“Revenue is vanity, profit is sanity, but cash is king.”
This old saying pinpoints where cash flow belongs in the financial pecking order: second to none. But projecting cash flow is notoriously tricky—sales fluctuations, late customer payments, market shifts, and unforeseen expenses can all wreak havoc on your forecasts.
However, by dialing in your DSO, you regain control over at least one critical variable: incoming cash. Understanding and actively managing your DSO gives you a much clearer picture of when payments are likely to arrive, allowing you to create far more accurate cash flow projections. Along with helping you avoid painful cash crunches, doing so allows you to optimize your working capital. This way, you can be sure you’re never holding too much or too little cash. For an even more comprehensive forecast, consider combining DSO with other key metrics like accounts receivable turnover ratio and average collection period.
Identify risky customers
Although it’s inherently backwards-looking, DSO can be a powerful early warning system for problematic payment behavior. A sudden spike in a client’s DSO could be a red flag that they’re under financial duress. But it could just as easily be due to some more benign reason, like a one-off processing delay or internal restructuring. It’s important to handle these situations delicately—how you respond should depend on the client’s history. If they have a strong track record of on-time payments, letting a late payment slide one month might be the right call. But if it starts to become a pattern, it might warrant a more thorough review of their creditworthiness and payment terms.
The real strategic value of DSO comes from combining it with other data sources. Integrating DSO with historical payment data and real-time analytics empowers you to proactively identify clients who pose a higher risk of default before problems escalate.
Reduce your DSO through automation
If your DSO isn’t where you’d like it to be, there are many proven ways to gradually bring it down over time—one of the most powerful of which being AI-powered automation. Stuut’s AI agents are designed to do just that by streamlining all aspects of your AR process:
- Faster payments, less hassle: Our AI agents handle the routine tasks that bog down collections, such as invoice follow-ups and cash application. This speeds up payment cycles and frees your team to focus on higher-value work. Humans are kept in the loop for exceptions and escalation.
- Nip problems in the bud: Our agents integrate seamlessly with your CRM, CMS, and ERP systems to catch invoice errors before they cause a cascade of downstream issues that inflate your DSO.
- Seamless payments across the board: Consolidating all payment types into a single seamless experience makes it easy for your employees and customers to process payments as quickly as possible.
Contact Stuut today and learn how we can help you achieve DSO that’s at the top of your industry.