What Is DSO and Why Is It the Lifeline for Accounts Receivable?

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Published on5 min read

Days Sales Outstanding (DSO) is a metric that every finance team should watch closely. So what is it, how do you calculate it, and why is it so important? We tell you everything you need to know about DSO in this blog.

What Is DSO and Why Is It the Lifeline for Accounts Receivable?

Picture an astronaut floating in space. What’s the one thing keeping them alive?

You guessed it, it’s a steady supply of oxygen. Just like an astronaut needs oxygen, a business needs cash to survive.

For companies that make a considerable amount of their sales on credit, Days Sales Outstanding (DSO) is a pretty good indicator of the business’ cash availability and overall financial health. Keeping a close eye on DSO and its trends is essential for any finance team in monitoring and managing the business’ cash flow.

What does outstanding receivables mean?

Outstanding receivables refers to the debt owed to a company when they’ve provided a product or service but accept payment from a customer later. Since accounts receivable will be converted to cash, it’s considered a short-term asset on the balance sheet.

What is DSO and why does it matter so much?

DSO (also referred to as the average collection period or days receivables) helps finance leaders understand the average number of days it takes to receive payment after a sale is made. A low DSO means that it takes your company a reasonably short time to collect payment while a high DSO means that it takes your company longer.

Not only is DSO a measurement of how long it takes to receive payment, but it’s also a reflection of customer satisfaction, customers’ credit worthiness, and the effectiveness of your collections team. (More on this later.)

With the economic pressures of the pandemic, C-suite leaders now lean on their finance team's guidance more than they did before to inform their decision making. A Gartner survey from April 2020 found that 70% of finance leaders were conducting cash flow forecasts more frequently and 75% were reporting to their C-suite at least once a week.

With so many insights coming from this one metric, you’ll want to have easy access to this data, letting you report on the status of receivables efficiently and accurately to leadership. You can track DSO proactively and automatically with accounts receivable software, meaning less work for you.

How do you calculate DSO?

If you want to calculate DSO manually, here’s how to do it. For the period you’re calculating (a single month for instance) you’ll need to divide total receivables due by the total sales you’ve made on credit and multiply this by the number of days. The formula looks like this.

Days Sales Outstanding equals Accounts Receivable divided by Total Credit Sales, times the number of days

How do you calculate DSO for 3 months?

For businesses with seasonal sales or fluctuating sales month over month, calculating your DSO over the course of a quarter instead of a month is a great way to normalize your data and see trends over time. If you want to calculate your DSO for the quarter, take your total receivables for those 3 months divided by total credit sales during that period and multiply this by 90.

Days Sales Outstanding for three months equals Accounts Receivable divided by Total Credit Sales, times 90 days

What is a good DSO?

According to the Credit Research Foundation’s National Summary of Domestic Trade Receivables, the average DSO in Q2 of 2020 was 41.56 days. In general, anything below 45 days is considered to be a low DSO. But since DSO ranges wildly from industry to industry and from business to business, it’s a good idea to look at companies that are within your industry and have similar terms to see how you compare. To get a full picture of your company’s operations, it’s best to look at trends in your DSO rather than focus only on the number itself.

What could be causing a high DSO?

There are a couple reasons your DSO could be trending higher. It could be an indication that customer satisfaction is low and as a result, customers are taking their time to pay you—or aren’t paying. In the case of the latter, it could be that your sales team is extending credit to customers they shouldn’t.

A higher DSO could also be a result of inefficient collections processes. Getting away from highly manual accounts receivable processes in favor of automation reduces the length of the cash conversion cycle significantly. PYMNTS.com’s recent B2B Payments Innovation Readiness report found that businesses that rely on manual AR processes tend to have 30% longer average DSO compared to those with medium to high levels of AR automation.

5 strategies for improving DSO

Here are some strategies you can use to reduce DSO:

1. Make it easy for customers to know what they owe

Giving customers visibility into all their current and past invoices makes it much easier for them to know exactly what they owe and when payment is due.

2. Get paid faster by embracing digital payments

Accepting digital payments means no more waiting on checks to arrive. When made through an online portal, digital payments also eliminate the issue of cash getting tied up in the process of matching payments with open AR, since remittance data is captured at the time a payment is made. Dollars and data move together.

3. Incentivize early payments with discounts

Discounts can be a great way to incentivize customers to pay you early. But, as managing which customers are eligible for discounts and accounting for them later can be a nightmare, teams are often hesitant to use them. The right AR platform with built-in tools to help you collaborate with your customers can eliminate this block, as you’re able to communicate discounts to a targeted selection of customers and even require a specified reason for the discount when payment is made.

4. Automate payment reminders

Send customers personalized notifications and reminders on when it’s time to pay. Nudging your customers in this way both saves your team time and preserves customer relationships by avoiding what could become confrontational collections calls.

5. Set customers up with autopay

You can make the payment experience even more convenient for customers when you introduce the option to set up autopay. With payments being made from their account on a set timeline automatically, customers have less to think about and you know for sure you’ll be paid on time.

A modern AR Platform can be your business’ lifeline when it comes to staying on top of outstanding accounts receivable and maintaining control of your cash position. Interested in learning about Versapay’s AR solutions? Find more details here.