March 8th, 2021
A healthy cash flow is a top priority for any business. From an accounts receivable (AR) perspective, achieving this goal basically comes down to getting paid on time. Routine DSO calculations are helpful performance indicators in this regard, because they tell you exactly how long it takes you to get paid on average.
Considering a company’s DSO is directly associated with business prosperity, most companies aim to keep this number as low as possible. Or rather, most companies aim to get paid as quickly as possible. Many turn to electronic invoicing to get the job done.
What Is DSO?
DSO stands for Days Sales Outstanding, and it’s an important KPI for AR professionals. Simply put, it’s the average number of days that it takes to collect outstanding payments from customers. That is, the time between when an invoice is sent and when the payment is received. DSO is often calculated on a monthly quarterly, or annual basis.
How to Calculate Days Sales Outstanding
It’s quite easy to calculate days sales outstanding. The DSO formula looks like this:
(AR Balance/Credit Sales) x Number of Days in Period = Days Sales Outstanding
In the above DSO calculation, AR Balance refers to the AR balance on credit sales. It is the total amount of money due for all goods and/or services that have been delivered but have not yet been paid for. In other words, the AR balance is the amount of money owed by customers for purchases made on credit during a specific time period. Even though the AR team hasn’t actually received this money, it’s listed as a current asset on the balance sheet.
Credit Sales is equal to the monetary value of all credit sales during a given period. This is calculated by subtracting sales returns, sales allowances, and cash sales from total sales.
Number of Days in Period are just that; the number of days in the period for which you would like to calculate days sales outstanding.
Example of How to Calculate Days Sales Outstanding
Suppose a company wants to calculate days sales outstanding from the past year. To make things easy, let’s say that the company had an AR balance of $100,000 during the 365-day period in question. Their total credit sales during that same period amount to $1,000,000.
($100,000/$1,000,000) x 365 = 36.5 days sales outstanding (DSO)
What’s a Good DSO?
The average number of days it takes for customers to remit payments can vary significantly across industries. As a general rule of thumb, it’s important for companies to benchmark AR performance by checking how their DSO compares with the industry standard. Dun & Bradstreet and the Credit Research Foundation release quarterly Accounts Receivable and Days Sales Outstanding Industry Reports for exactly this purpose.
Undeniably speaking, however, the lower the DSO the better. That’s because there’s a direct link between day sales outstanding and company performance. In general, the fastest collectors, or those that get paid within 30 days, are the top performers. After all, these companies tend to have a lot more cash on hand. This liquidity, in turn, creates business agility. A high DSO, on the other hand, could mean a lack of available funds necessary to keep the business going.
How Electronic Invoicing Can Lower DSO
There are a lot of tips for lowering your days sales outstanding. From extending early payment discounts and performing credit checks on customers to active follow up from the AR team, nothing has a bigger impact on lowering your DSO than optimizing invoicing processes.
Sending invoices and receiving payments is what AR is all about. While it’s undoubtedly important to define payment terms and know who you’re in business with, this part is over relatively quick. Once the initial contract is signed, achieving a low DSO comes down to efficient invoice processing.
To limit invoice disputes, cut back on human error, spot inconsistencies, and ultimately ensure payments are made on time, the majority of large enterprises and SMEs have implemented an electronic invoicing solution. Although many companies choose to do this on their own, electronic invoicing is increasingly enforced from the buyer side. This has made electronic invoicing capabilities a huge plus, even for small businesses. So even when electronic invoicing is a requirement, it still contributes to a low DSO. It’s a win-win.