DSO: what is it en why is DSO important?

by 26/11/2020Blog

DSO or days sales outstanding is a metric used for payments that don’t have to be completed upon receiving goods or services immediately. It indicates how many days a company waits for these payments after delivering goods or services. DSO is the most frequently used metric in credit management and is important in debtor management too.

 

What’s DSO?

DSO stands for days sales outstanding. The ratio indicates the number of days between delivering goods or services to a client and receiving its payments. It’s an essential ratio in credit management because it shows the average duration of receiving payments. A low DSO is good for your company as it means that your company receives payments quickly.

 

How to calculate DSO? 

This is the general formula:

payments to be received in a certain period

                                                                                                     x number of days in that period

total sales on credit for that period

The result is shown in days. It’s the average number of days it takes for clients to pay for the received goods or services.

It’s possible to calculate DSO according to different types of periods. You can opt for a monthly, quarterly, semestrial or yearly one but most calculations are made based on a monthly period.

Let’s illustrate DSO with a monthly example:

In June, a company has an average of 950 000 EUR outstanding invoices. In the same month, it closes a number of deals on credit worth 1 000 000 EUR. To calculate its DSO, the company uses the following formula: (950 000/1 000 000)*31 = 29 days

Whether this is a good or a bad result depends on the type of company and its payment terms. If the result is within the payment terms of the company, it is doing well. If the result significantly exceeds the payment terms, it indicates there’s a problem in the company’s credit management. Additionally, it proves to be interesting to benchmark your DSO with other companies of the same industry to find out if your company is doing well in general.

 

Why is DSO important?

DSO provides insight into the number of days it takes a company to collect payment after a sale has been made. In a sense it’s part of the cash conversion cycle, which is a metric expressing how quickly investments turn into cash.

It’s an important metric in credit management since it shows the status of debtor management: is the company doing well or should it apply any changes?

A DSO that has become smaller or larger could be ascribed to a change in the sales policy. For example, the company could be selling more to clients with a lower creditworthiness. The company could also have made more credit deals with longer payment terms to try boost their sale figures.

Companies with a high DSO have a lower cashflow, which influences their liquidity negatively. These companies will have a harder time when unforeseen circumstances occur. Low liquidity metrics also impact a company’s solvency.

Would you like to lower your DSO?

 Man met tablet bekijkt financiële berekeningen en DSO

 

What to watch out for? 

It’s possible for DSO to provide you with an altered view of your company’s health status. Since it’s expressed in an average number, the metric is liable to the pitfalls known to average numbers. Outliers may impact DSO significantly. For instance, if a company is doing well and has a DSO of 20 days but its biggest client is suddenly in financial trouble, the company’s DSO will skyrocket.

 

How can you improve your DSO?

 

The sales and finance department both play a role in improving the metric. Credit managers in particular can lower the company’s DSO in a number of ways. These are a couple of tips to do so:

  • Refine customers’ credit risk assessments. Your customers change and so does their credit risk. Especially in rapidly changing or turbulent times it is important to adjust your credit policy accordingly. Data is your best friend in doing so.
  • Follow up customers’ payments closely. Each delayed day increases the credit risk. Don’t just send payment reminders when dealing with overdue invoices, but consider sending preventive reminders just before the last payment date as well.
  • Outsource the collection of invoices that remain unpaid to experts as soon as possible. Determine in advance at which point these invoices should be outsourced so that no time is wasted.

 

Unfortunately, collecting unpaid invoices is often a difficult process that is hard to follow up once the file is passed onto an external debt collector. You can learn more about the debt collection process here. A centralizing platform such as Virteo allows companies to simplify, monitor and adjust this process where necessary. They can also determine the ethical approach of debt collectors towards their customers, which ensures these debt collectors process files according to the company’s ethical charter.

Read more articles:

Curious to see how we lower your DSO?