Image may be NSFW.
Clik here to view.
The Formula for Days Sales Outstanding Calculation (Table of Contents)
What is Days Sales Outstanding Formula?
Days Sales Outstanding Formula, also known as Days Receivable or DSO, a method to estimates the days in which the Accounts Receivable would realize, is calculated by dividing Accounts Receivable by Average Sales per Day (Annual Sales / 365 days).
Days Sales Outstanding Formula
Days Sales Outstanding (DSO) formula is represented as below,
How to Calculate Days Sales Outstanding (DSO)?
A company would require two items to derive DSO, and these are Sales and Accounts Receivables. To avoid the concentration issues (the sales of the company could be seasonal in nature, or uneven across the months or quarter,) it’s better to take average accounts receivable (monthly, quarterly or semi-annually), and to take Annual Sales at the denominator.
Days Sales Outstanding Formula Interpretation
Days Sales Outstanding Formula denotes the average number of days, a company would require to receive the payments since the occurrence of sale. A DSO of 45 days is considered adequate, though it depends upon industry to industry, structure, and operations of the business.
This formula indicates the outstanding sales in terms of days. It could be calculated for any period of time, but generally, it is calculated on a monthly basis.
If the ratio is too high, it means there is a problem in the credit issuance and the process of collection is slow and ineffective.
On the contrary, if the day’s sales outstanding ratio is quite low, this indicates the company’s inability to fully utilize the credit policies to enhance its revenue generation activity.
Examples of Days Sales Outstanding (with Excel Template)
Let’s see some simple to advanced examples to understand the calculation of the day’s sales outstanding equation better.
Example #1
Company ABC Inc. has a balance of $7,00,000 for Accounts Receivable for the month of September and the company has done a credit sales of $12,00,000 of credit sales. The September month is of 31 days, and let’s calculate the Days Sales Outstanding for September.
Below is data for the calculation of the day’s sales outstanding.
Image may be NSFW.
Clik here to view.
Therefore, the calculation of days sales outstanding will be as follows,
Image may be NSFW.
Clik here to view.
- = ($700,000.00*31.00)/$1200000
Days Sales Outstanding will be –
Image may be NSFW.
Clik here to view.
- Days Sales Outstanding = 18.08 days
Here, the number of 18.08 days of DSO reflects the excellent ability to convert its accounts receivable in cash. Such a lower turnaround time would lower the working capital requirement of the company. It shows the companies superiority in the cash collection or better product offering or both. Because generally 45 days of DSO is considered good depending upon the business and the industry in which the company operates.
Example #2
Apple Inc. has an Account Receivable of $ 22,926 for a 3 month period as of Sep 2019. For the same period, Its revenue stood for $64,000 million. Calculate the Days Sales Outstanding of Apple Inc. for a period of 3 months in September. For the sake of convenience, you can take 90 days instead of a month’s period.
Solution
Below is data for the calculation of the day’s sales outstanding.
Image may be NSFW.
Clik here to view.
Therefore, the calculation of days sales outstanding will be as follows,
Image may be NSFW.
Clik here to view.
- =($22926.00*90.00)/$6400.00
Days Sales Outstanding will be –
Image may be NSFW.
Clik here to view.
- Days Sales Outstanding = 32.24 days
This answer reflects that for a 90 day period, Apple Inc. realizes its Accounts Receivable in a manner of 32.24 days. It is well below 45 days, so we could say, the company has a robust system in place for collecting Accounts Receivables and enjoys a strong liquidity position.
Example #3
Let’s take one more example to understand it further. Microsoft Inc. has an Account Receivable of $ 19,087 for a 3 month period as of Sep 2019. For the same period, Its revenue stood for $33,055 million. Calculate the Days Sales Outstanding of Microsoft Inc. for a period of 3 months as of September. For the sake of convenience, you can take 90 days instead of a month’s period.
Solution
Below is data for the calculation of the day’s sales outstanding.
Image may be NSFW.
Clik here to view.
Therefore, the calculation of days sales outstanding will be as follows,
Image may be NSFW.
Clik here to view.
- =($19087*90.00)/$33055
Days Sales Outstanding will be –
Image may be NSFW.
Clik here to view.
- Days Sales Outstanding = 51.97 days
So, the DSO of Microsoft Inc. is approximately 52 days and that means, it will take higher days than Apple Inc. to recover the sales made on credit mode.
Benefits
It is an important ratio for evaluating the working capital and liquidity of the company.
- If a DSO (Days Sales Outstanding) is low, It suggests that company would have the adequate cash flow to fund its expenses and working capital, but if the DSO is very high, it is a negative sign because either the debts are going bad or the company’s collection policy is faulty. These issues would lead to deteriorating the company’s ability to pay its dues such as salaries, creditors, and other expenses, and the company may resort to suffice this gap with borrowing funds by worsening its condition further.
- This ratio helps the company to do introspection in the operations and effectiveness of the sales and accounts receivable departments. A sharp increase in the DSO would force the company to take extreme and novel measures so, that the company would be able to manage its funds on a regular basis. Three are three reasons for it:
- The customer is unable to pay dues on time, this situation calls for a thorough check on the dept. involved in judging the creditworthiness of the client.
- Shipping and Delivery related issues along with the sub-par quality of the products also sometimes force the sales staff to offer a longer credit period. Hence, better quality management should be the priority of management.
- Also, it could be due to a decrease in average sales, and in this scenario, it’s better to revamp the sales division and hire better staff.
Limitations
Similar to the other metrics of evaluating the efficiency of the business and its operations, DSO also has some limitations which should be known to and taken care of by investors.
- It is one of the best tools to gauge the liquidity position of the company, and to compare different companies on this parameter. But, one needs to be cautious while comparing as companies from different industries, different business models, and different capital structures, tend to have different answers. It is only comparable when both the companies are in a similar industry with similar business models.
- Again, the limitation of comparison is not only restricted to Industry, business models, and business structures but also to the proportion of cash and credit sales in the company too. If both the companies do not have a similar bifurcation in credit and cash sales, the DSO would not provide a clear picture.
- Furthermore, to evaluate the Accounts Receivable efficiency of the business, DSO could not be used in isolation. As it is also affected by the variation of credit sales as well. If in a particular season, the sales are higher than DSO would come lower whereas there has not been any fundamental change in the collection efficiency of the company. So, to avert this issue, it needs to be looked at with other metrics and not alone.
Recommended Articles
This has been a guide to the Days Sales Outstanding Formula. Here we discuss the calculation of the days sales outstanding (DSO) using its formula along with examples and downloadable excel template. You can learn more about financial analysis from the following articles –
- What is the Pearson Correlation Coefficient Formula?
- What is Standard Error Formula?
- What is Lien Sale?
- Days Inventory Outstanding (DIO)
- Days Payable Outstanding (DPO)
- Credit Sales Meaning
- Examples of Accounts Receivable
The post Days Sales Outstanding Formula appeared first on Wallstreet Mojo.