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Days Sales Outstanding Definition
Days Sales Outstanding is the average collection period of a company. Days Sales Outstanding is also known as “days receivable”, “average collection period”, or “average debtor days”. It is calculated to find out the average number of days a company takes to collect the dues owed by other individuals and companies. This ratio reflects the management of the company’s accounts receivable. It is calculated on a monthly, quarterly or annual basis. It is a component of the cash conversion cycle.
Calculating the Days Sales Outstanding
The formula for calculating the Days Sales Outstanding is,
DSO= (Accounts receivable/ Total Credit Sales) * Number of Days
DSO= Accounts receivable/ (Total Credit Sales/ Number of Days).
A Little More About Days Sales Outstanding
Companies provide goods and services on a credit basis and later collect the payments for those. DSO is the average number of days it takes to make that collection. It is important for a company to collect the outstanding account receivables in a timely manner. According to the time value of money principle the more a company waits for receiving the moment the more they lose out on profit. As soon as the company collects the payment, they can roll the money and make a profit out of it.
A high DSO value indicates the company takes a longer period to collect its account receivables whereas a low value shows it collects the account receivables quickly. Generally, DSO value under 45 is considered to be low, but that depends on the size and nature of the business. A small business may find it difficult to run the cash flow with a DSO value of 30, while for big businesses it is never an issue.
It is important to maintain a standard DSO value according to the condition and nature of the business. A high DSO may result in a cash crunch while a very low DSO may affect the customer base. Companies with very low DSO often lose clients due to its strict account receivable collection policy.
A well-maintained DSO ratio reflects the efficiency of the collection department. It is better to judge the efficiency of the company’s cash flow management by considering the trend of the DSO. A trend reflects it much vividly than an individual DSO value.
References for Days Sales Outstanding
Academic Research on Days Sales Outstanding
Supply chain performance benchmarking study reveals keys to supply chain excellence, Stewart, G. (1995). Logistics Information Management, 8(2), 38-44. This paper describes a system to better assess the performance of supply chains. It provides both quantitative and qualitative measures, and offers supply-chain best practices.
An analysis of working capital management results across industries, Filbeck, G., & Krueger, T. M. (2005). American Journal of Business, 20(2), 11-20. Effective management of a company’s daily assets and liabilities (working capital management) can reduce financing costs and free up cash. This study examines working capital management data from a survey of companies and finds differences across different industries and across time.
The effect of working capital management on firm’s profitability: Empirical evidence from an emerging market, Charitou, M. S., Elfani, M., & Lois, P. (2010). Journal of Business & Economics Research, 8(12), 63-68. This study examines the effects of working capital management on profitability in the emerging market of Cyprus. After looking at ten years of data from companies on the Cyprus Stock Exchange, the authors conclude that good capital management leads to greater profitability.
Trade credit, product quality, and intragroup trade: some European evidence, Deloof, M., & Jegers, M. (1996). Trade credit, product quality, and intragroup trade: some European evidence. Financial management, 33-43. This paper partially confirms previous work which shows that sellers extend credit to customers so that customers can assess the quality of the sellers’ goods. The paper also finds other reasons that sellers extend credit, and finds that sellers are less likely to extend credit when they are short on cash.
Trade credit, quality guarantees, and product marketability, Long, M. S., Malitz, I. B., & Ravid, S. A. (1993). Trade credit, quality guarantees, and product marketability. Financial management, 117-127. The authors propose that the main purpose of extending credit to customers is to prove the quality of products. They find that smaller firms, firms with a longer production cycle, and firms that make hard-to-test goods will extend credit over longer periods of time than other firms.
Cash-to-cash: the new supply chain management metric, Theodore Farris, M., & Hutchison, P. D. (2002). International Journal of Physical Distribution & Logistics Management, 32(4), 288-298. The cash-to-cash (C2C) cycle is the time between when a company pays for inventory and gets cash from customers. This paper examines C2C as measure of supply chain management performance.
The relationship of cash conversion cycle with firm size and profitability: an empirical investigation in Turkey, Uyar, A. (2009). The relationship of cash conversion cycle with firm size and profitability: an empirical investigation in Turkey. International Research Journal of Finance and Economics, 24(2), 186-193. The cash conversion cycle (CCC) is the amount of time it takes a company to convert its inventory and other costs into cash from sales. This study looks at the relationship between the length of the CCC and company size and profitability. After examining data from companies on the Istanbul Stock Exchange, the author finds that longer CCCs correlate with smaller, less profitable companies.
The relationship between working capital management and profitability: Evidence from the United States, Gill, A., Biger, N., & Mathur, N. (2010). Business and economics journal, 10(1), 1-9. The cash conversion cycle (CCC) is the amount of time it takes a company to convert its inventory and other costs into cash from sales. This paper examines 88 American companies over 3 years to better understand the relationship between CCC and profitability. They find that good CCC leads to greater profitability.
The effects of fee pressure and client risk on audit seniors’ time budget decisions, Houston, R. W. (1999). The effects of fee pressure and client risk on audit seniors’ time budget decisions. Auditing: a journal of practice & theory, 18(2), 70-86. This study looks at the effects of fee pressure and client risk on senior auditors’ planning and budgeting decisions.
The effects of family ownership and management on firm performance, Lee, J. (2004). SAM Advanced Management Journal, 69, 46-52. This study seeks to understand the relationship between family ownership and company efficiency and employee productivity.
Economic benefits of enterprise resource planning systems: some empirical evidence, Matolcsy, Z. P., Booth, P., & Wieder, B. (2005). Accounting & Finance, 45(3), 439-456. Enterprise resource planning (ERP) systems integrate all aspects of a business’s operations. This study compares 2 years of data from companies and finds that companies that use ERP systems were more efficient, had greater liquidity and may have been more profitable.