What Is Days Sales Outstanding (DSO)? How to Calculate and Why It Matters

Days Sales Outstanding (DSO) is a measure of how long it takes for a company to collect payment after making a sale. It's calculated by taking the total accounts receivable, multiplying it by the number of days in the period, and then dividing by the total credit sales during that time. In simple terms, DSO tells you the average number of days it takes for your invoices to get paid.

• What is Days Sales Outstanding (DSO)?
• Importance of DSO in financial management?
• How to calculate Days Sales Outstanding
• Factors affecting Days Sales Outstanding
• What's considered a good DSO?
• Best practices for managing DSO
• How to track DSO

Days Sales Outstanding is a crucial metric for understanding the health of a business's cash flow. The speed at which a company collects payments can have a direct impact on its ability to meet financial obligations, invest in new opportunities, and maintain smooth operations.

A low DSO means that cash is flowing into the business quickly, allowing it to pay bills, salaries, and other expenses on time. This efficient cash flow can reduce the need for borrowing and minimize interest expenses, ultimately leading to stronger financial stability.

A high DSO indicates that the company is waiting longer to collect its payments. This delay can create cash flow gaps, forcing the business to dip into reserves or take on debt to cover shortfalls. Over time, consistently high DSO can signal potential problems with customer creditworthiness, inefficient invoicing processes, or weak credit control policies.

By keeping a close eye on DSO, businesses can better manage their cash flow, including recurring revenue streams, plan for the future, and ensure they have the liquidity needed to thrive.

(Back to top)

Calculating DSO is relatively straightforward and gives you insight into how quickly your business is converting sales into cash. Here's a step-by-step guide:

1. Determine the period: Decide on the time frame you want to measure — this could be a month, a quarter, or a year.
2. Gather your numbers:
   Accounts Receivable (AR): Find the total amount of money owed to your company by customers at the end of the period.
   Total Credit Sales: Calculate the total sales made on credit during the same period.
3. Apply the formula: Multiply the total Accounts Receivable (AR) by the number of days in the period. Then, divide that result by the Total Credit Sales for that period.
   DSO = (Total Accounts Receivable × Number of Days in the Period) / Total Credit Sales
4. Interpret the result: The resulting number is the average number of days it takes for your business to collect payment after a sale. For example, if your DSO is 45 days, on average, it takes your customers 45 days to pay their invoices.

(Back to top)

Several factors can influence DSO, making it essential for businesses to understand what drives changes in this metric. Here are some of the key factors:

1. Credit policies: Your payment terms directly impact DSO. Offering 60- or 90-day terms can increase DSO, while stricter policies typically result in faster payments. Consider offering early payment discounts to encourage quicker payments. For example, a 2% discount for payments within 10 days can significantly reduce your DSO. However, balance these incentives with your cash flow needs and profit margins.
2. Customer payment behavior: Reliable customers who pay on time help keep DSO low. Identify and address issues with consistently late-paying customers. Regular communication can often improve payment behavior. Consider implementing a customer scoring system based on payment history. This can help you prioritize follow-ups and tailor your approach to different customer segments.
3. Invoicing process: Delays or errors in invoicing slow down payments. Implement a system to send invoices promptly and accurately. Clear, detailed invoices with all necessary information can speed up the payment process. Consider including all relevant purchase order numbers, itemized lists of goods or services, and clear payment instructions. Automated invoicing systems can help reduce errors and ensure timely delivery of invoices.
4. Industry norms: Different sectors have varying standard payment terms. For example, construction often has longer DSOs due to project complexity. Understand your industry's norms to set realistic DSO goals. Research industry benchmarks and compare your DSO to competitors. This can help you determine if your DSO is competitive or if there's room for improvement.
5. Economic conditions: During economic downturns, customers might take longer to pay. Build flexibility into your processes to handle these fluctuations without severely impacting your cash flow. Consider creating a contingency plan for economic downturns, which might include tightening credit policies or increasing communication with customers about payments.
6. Geographical factors: If you operate internationally, be aware of regional payment practices. Some cultures typically have longer payment cycles, which can increase your overall DSO if not managed carefully. Research local payment norms before entering new markets. You may need to adjust your expectations and strategies for different regions to maintain a healthy overall DSO.
7. Customer creditworthiness: The financial health of your customers directly impacts their ability to pay on time. Conducting thorough credit checks and setting appropriate credit limits can help mitigate the risk of late payments and manage DSO effectively.
8. Seasonal fluctuations: Many businesses experience seasonal changes in sales volume, which can affect DSO. For example, retailers often see increased sales (and potentially longer DSO) during holiday seasons. Understanding these patterns can help you prepare for and manage DSO fluctuations throughout the year.
9. Product or service complexity: The nature of what you're selling can impact DSO. Complex products or services often require longer payment terms due to extended implementation or delivery times. Consider breaking down complex projects into smaller, billable milestones to improve cash flow and reduce overall DSO.
10. Customer size and type: Large corporations often have standardized payment processes that can lead to longer DSO, while smaller businesses might pay more quickly. Government contracts typically have longer payment cycles. Tailor your expectations and strategies based on your customer mix.

(Back to top)

What qualifies as a "good" DSO can vary significantly depending on the industry, business model, and payment terms. However, as a general rule, a lower DSO is often preferable, indicating that a company is collecting payments efficiently and maintaining healthy cash flow.

Ultimately, a good DSO is one that aligns with your industry standards, supports your cash flow needs, and is consistently improving. In many industries, a DSO of 30 to 45 days is typically seen as a good benchmark. This range suggests that a company is getting paid within a reasonable time frame, balancing the need to offer credit terms that attract customers with the need to maintain steady cash flow. Timely payments are particularly important in accounting for small business, as there is little room for error.

However, the context matters. Keep the factors above in mind as you consider what's reasonable for your industry and business.

(Back to top)

Good DSO management, a key component of revenue lifecycle management, means more cash on hand, happier customers, and better growth opportunities. These DSO best practices help you get paid faster, improve customer relationships, and make for smarter credit decisions.

1. Set clear payment terms. Clearly communicate payment expectations from the start. Consider offering early-payment incentives to encourage faster payments. Make sure these terms are prominently displayed on all invoices and contracts. Regularly review and update your payment terms to ensure they align with your business needs and industry standards.
2. Conduct credit checks and set limits. Before offering credit, assess customer creditworthiness. Start new customers with lower credit limits and increase them as they demonstrate reliability. Develop a clear policy for credit assessments and stick to it consistently. Regularly review and update credit limits based on payment history and changes in customer financial status.
3. Invoice quickly and accurately. Send invoices immediately after a sale or project milestone. Use a checklist to ensure all necessary details are included, reducing disputes and delays. You can also consider implementing an automated invoicing system to generate and send invoices as soon as a sale is completed or a milestone is reached. This not only speeds up the process but also reduces the chance of human error. Look for solutions that can handle any billing frequency — monthly, quarterly, or annually — to ensure timely and accurate invoicing.
4. Offer multiple payment options. Make it easy for customers to pay by providing various payment methods. Options like online payments or automatic bank transfers can speed up the collection process. Consider implementing a customer portal where clients can view their invoices and make payments easily, ideally one that consolidates payments from all your sales channels. The more convenient you make it for customers to pay, the more likely they are to do so promptly.
5. Regularly monitor receivables. Schedule weekly reviews of accounts receivable. Use automated reminders for upcoming and overdue payments to catch issues early. Create a system for escalating overdue payments, starting with friendly reminders and progressing to more formal communications. Consider assigning a dedicated team member to oversee this process and ensure consistency.
6. Maintain strong customer relationships. Build open lines of communication with customers. If a payment is late, reach out to understand why and work together on a solution, such as a short-term payment plan. Regular check-ins with customers can help you anticipate payment issues before they occur. Consider implementing a customer feedback system to continuously improve your billing and payment processes.
7. Implement automated tools. Use accounting software to streamline invoicing, payment reminders, and aging reports. Automation helps ensure consistent follow-up and reduces manual errors. Choose a system that integrates with your existing tools, provides real-time insights into your DSO performance, and can handle complex billing scenarios. Predictive analytics capabilities can help forecast potential payment delays and simplify invoice and credit information management.
8. Align sales and finance teams. Ensure your sales team understands the importance of DSO. They can help by accurately setting customer expectations about payment terms during the sales process. Consider including DSO performance in sales team metrics to encourage them to prioritize deals with customers who have good payment histories. Regular meetings between sales and finance can help identify and address potential DSO issues early.

(Back to top)

Effectively tracking DSO helps you spot trends, identify issues early, and make informed decisions about your accounts receivable. Here are practical ways to keep tabs on your DSO:

1. Use accounting software with reporting features: Your revenue operations team can run weekly DSO reports to spot trends. Compare DSO across different customer segments or product lines to identify which areas need attention. Set up automatic email alerts for these reports to ensure your team reviews them regularly. This proactive approach helps you catch potential issues before they become problems.
2. Set up alerts and dashboards: Create a DSO dashboard that shows your current DSO, a 30-day trend, and how it compares to your targets. Configure alerts for when individual invoices go past due, so you can follow up promptly. Set up notifications for when your overall DSO exceeds your target by five or more days. This gives you a quick, visual way to gauge your DSO health and react quickly to changes.
3. Integrate accounting software with CRM: Add a "Payment Status" field in your CRM for each customer. Train your sales team to check this before each customer interaction, so they're aware of any payment issues. Create a weekly report of customers with overdue invoices for sales follow-up. This integration ensures your sales team can help with collections while maintaining good customer relationships.
4. Use predictive analytics: Identify customers with worsening payment trends and flag them for early intervention. Forecast your cash flow based on predicted DSO for the next 30, 60, and 90 days. Use these predictions to adjust credit terms for high-risk customers. Predictive analytics helps you stay ahead of potential cash flow problems and make informed decisions about customer credit. Consider integrating machine learning algorithms to continuously improve your DSO predictions and risk assessments over time.

(Back to top)

To manage DSO effectively, focus on quick and accurate invoicing, clear payment terms, and regular monitoring of receivables. Use technology to automate tracking and predict payment trends. Remember, a well-managed DSO isn't just about numbers — it's about building strong customer relationships and creating a more financially stable business.

(Back to top)