What is days sales outstanding? How to calculate and improve DSO

It’s important to keep your accounts receivable to a minimum. But to get a handle on your accounts receivable, you must first determine how long it takes to collect on an account past due. Days sales outstanding is a metric that can help you understand how long it takes clients and customers to pay you.

Use these links to get a specific answer, or keep reading to learn more about days sales outstanding:

• What is days sales outstanding (DSO)?
• Benefits of days sales outstanding
• Components of the DSO formula
• How to calculate DSO with the days sales outstanding formula
• Days sales outstanding calculation example
• Additional days sales outstanding analysis
• How do days sales outstanding affect business finances?
• What is a good DSO ratio?
• Why would days sales in receivables increase?
• How to reduce and improve DSO

What is days sales outstanding (DSO)?

A company’s days sales outstanding (DSO) is the average number of days it takes the business to collect payment over a period following a sale. A lower DSO means you’re collecting balances past due faster. Days sales outstanding is also sometimes referred to as “days sales in receivable”.

Benefits of days sales outstanding

Days sales outstanding is a critical metric that reveals how quickly your business collects customer payments. Why does this matter? Because a healthy cash flow is the lifeblood of any successful business.

Understanding and tracking your DSO can unlock a wealth of insights and benefits, including:

Improved cash flow management

• Predictable cash inflows: DSO provides valuable clarity into how long it takes to convert sales into cash, allowing you to better manage your cash flow and forecast future liquidity.
• Reduced financing costs: Efficient collection processes reduce the need for external financing to cover short-term cash flow gaps, leading to cost savings on interest and fees.

Enhanced customer relationship management

• Identifying payment patterns: Tracking DSO helps identify customers who consistently pay late. You can use this information to address payment issues and improve customer relationships.
• Customized credit policies: Understanding individual customer payment behavior allows you to tailor credit terms, minimizing the risk of bad debt.

Financial health indicator

• Performance measurement: A low DSO indicates efficient collection processes and a strong cash position, reflecting positively on your company’s financial health.
• Benchmarking: Comparing DSO with industry averages helps assess the effectiveness of your credit and collection practices relative to competitors.

Operational efficiency

• Process improvement: Regularly reviewing DSO encourages businesses to streamline their invoicing and collection processes, enhancing overall operational efficiency.
• Resource allocation: Efficient collection processes free up resources that can be redirected to other areas of your business, such as sales or customer service.

Risk management

• Early warning system: A rising DSO can signal potential issues with customer creditworthiness or economic downturns, allowing you to take proactive measures.
• Reduced bad debt: Effective management of DSO helps minimize the risk of bad debt by ensuring timely collections and addressing overdue accounts promptly.

Investor confidence

• Transparency: Consistent monitoring and reporting of DSO provide transparency to investors about your company’s financial practices and cash flow stability.
• Attractive financial metrics: Maintaining a low DSO contributes to better financial ratios, making your business more attractive to investors and lenders.

Limitations of days sales outstanding 

While DSO provides valuable insight into how quickly your business collects payments, it's important to remember that it's just one piece of the puzzle when evaluating your overall financial health.

To truly understand your business's performance, it's important to analyze DSO in conjunction with other key performance indicators (KPIs) and financial ratios. For example:

Cash conversion cycle (CCC): The cash conversion cycle metric measures the time it takes to convert inventory into cash, encompassing the entire sales cycle, not just accounts receivable. It can reveal inefficiencies in your inventory management or production processes that impact your cash flow.

Accounts receivable turnover ratio: This ratio measures how often you collect your average accounts receivable balance during a specific period. A higher accounts receivable turnover ratio indicates that you're collecting payments more frequently, which is generally a positive sign for your cash flow.

Other limitations include: 

Seasonality: DSO can fluctuate depending on seasonal sales trends or industry-specific factors. To get a more accurate picture of your performance, you need to compare DSO over time and consider industry benchmarks.

Sales mix: If your business offers a variety of payment terms (e.g., net 30, net 60, etc.), DSO may not accurately reflect your overall collection efficiency. You may need to calculate DSO for different customer segments to get a more nuanced understanding.

Credit policies: Changes in your credit policies can significantly impact DSO. For example, extending longer payment terms to customers may increase DSO, even if your collection efforts remain efficient.

Components of the DSO formula

The days-sales-outstanding formula divides accounts receivable by total credit sales, multiplied by a number of days in a measurement period.

Your accounts receivable (A/R) is all outstanding payments owed to your company, and can be found by reviewing your balance sheet and income statement. Credit sales are sales to be settled on a future date.

For example, let’s say you have $20,000 in accounts receivable and sold $10,000 on credit in a 30-day period. Using the DSO formula, you find it takes an average of 60 days to collect your invoices. Most business owners compare figures quarterly or annually, not over prior time periods.

DSO only applies to businesses that issue credit sales. Cash sales have a DSO of zero, and you shouldn’t factor them into DSO calculations, as they will skew the metric.

How to calculate DSO with the days sales outstanding formula

The formula for days sales outstanding is:

(Accounts receivable ÷ total credit sales) x number of days = standard DSO

In addition to calculating the standard DSO on your accounts past due, you can calculate your best possible DSO. Your best possible DSO divides a current portion of your accounts receivable by total credit sales, multiplied by a number of days. The formula follows:

(Current accounts receivable ÷ total credit sales) x number of days = best possible DSO

Days sales outstanding calculation example

Here’s how to use the days sales outstanding formula:

Let’s use an example of a business that has $10,000 in accounts receivable on January 1, 2024. The following month, on February 1, 2024, the business has $12,000 in accounts receivable. The business also sells $8,000 in credit sales between January 1 and February 1.

Use these steps to calculate DSO:

1. Calculate average account receivable

First, we’ll find the average accounts receivable over the time period being analyzed:

($10,000 + $12,000) ÷ 2 = $11,000 average accounts receivable

2. Find total credit sales

In this case, we know that total credit sales over the time period being analyzed is $8,000.

3. Find the total number of days in the time period

January has 31 days, so 31 will be the number of days we use in the DSO formula.

4. Apply these numbers to the DSO formula

Using the DSO formula, we can calculate days sales outstanding with the numbers we’ve found. Given the DSO formula:

(Accounts receivable ÷ total credit sales) x number of days = standard DSO

($11,000 ÷ $8,000) x 31 = 42 days sales outstanding

Additional days sales outstanding analysis

Take your analysis even further. Follow these steps to calculate DSO and understand its full impact on your business. These insights can help inform strategies for improving your accounts receivable management.

Step 1: Gather necessary data

Collect data on total credit sales for the period you want to analyze (monthly, quarterly, or annually). Obtain the average accounts receivable balance for the same period. This can be found by averaging the beginning and ending accounts receivable balances.

Step 2: Calculate DSO

Use the formula: DSO = (Accounts Receivable / Total Credit Sales) x Number of Days. For example, if your average accounts receivable is $50,000, total credit sales are $200,000, and you’re analyzing a 30-day period, the calculation would be: DSO = ($50,000 / $200,000) x 30 = 7.5 days

Step 3: Compare against industry benchmarks

Research industry standards and benchmarks for DSO to see how your company compares to peers. This helps identify if your DSO is within an acceptable range or if it needs improvement.

Step 4: Track historical DSO trends

Analyze DSO over multiple periods (e.g., monthly or quarterly) to identify trends. Look for patterns or anomalies that may indicate issues or improvements in your receivables process.

Step 5: Identify influencing factors

Assess internal and external factors that may influence your DSO, such as:

• Seasonal sales fluctuations 
• Changes in credit policy or terms
• Economic conditions affecting customer payment behavior

Evaluate how these factors impact your DSO and address any negative influences.

Step 6: Evaluate collections process

Review your collections process to identify inefficiencies or areas for improvement. Check the timing and effectiveness of invoice follow-ups and payment reminders.

Step 7: Assess customer creditworthiness

Examine the creditworthiness of your customers to ensure they are capable of paying on time. Consider adjusting credit terms for customers who consistently pay late.

Step 8: Monitor cash flow impact

Analyze how DSO affects your cash flow. Higher DSO means cash is tied up in receivables, impacting your liquidity. Use cash flow forecasts to predict the impact of DSO on your financial stability.

Step 9: Implement improvement strategies

Based on your analysis, implement strategies to reduce DSO, such as:

• Offering early payment discounts
• Enforcing stricter credit policies
• Improving invoicing and collections processes

Step 10: Set targets and monitor progress 

Set realistic DSO targets based on your analysis and industry benchmarks. Regularly monitor progress towards these targets and adjust strategies as needed to ensure continuous improvement.

How do days sales outstanding affect business finances?

When the cash your clients owe your business sits in their bank accounts, it negatively affects your finances in a few ways. The most apparent is the loss of revenue.

When overdue accounts go past 120 days, the lesser your chances of collecting. If that happens, you stand to lose that amount on your pretax income. You may also lose out on an opportunity to expand or otherwise enhance your business because you won’t have the cash to invest.

Lost revenue may also result in cash flow problems that may lead you to seek outside financing. If you can’t pay your monthly operational costs, your interest payments may increase your cash burden. And if you send the account to a collection agency, they may collect a percentage of the balance.

What is a good DSO ratio?

Generally, a low DSO ratio is better for your business. But your ideal days-sales-outstanding ratio depends on your industry and type of business. According to the Credit Research Foundation, the average days sales outstanding for the first quarter of 2024 for domestic trade receivables was 35 days.

To understand the effectiveness of your accounts receivables process, analyze individual DSO values, and review trends in DSOs over time. DSOs may also vary according to seasonality. Generally, seasonal rises and falls aren’t a cause for concern. Instead, forecast your business’s cash flow to plan for seasonal changes.

Why would days sales in receivables increase?

An increase in days sales outstanding indicates that it may be taking your business longer to collect outstanding payments.

Reasons why you may see a higher DSO include:

• Customers are taking longer to make payments.
• Customers aren’t satisfied with your business or customer service, so they may be reluctant to pay.
• Customers with poor credit are making purchases on credit. So you may need to review your credit terms.
• Your sales team is extending flexible payment terms to help drive sales.

Applications of the DSO calculation 

The DSO calculation is a valuable tool with a range of applications in business management and financial analysis. Here are some key applications: 

Cash flow management

• Forecasting: DSO helps predict cash inflows, enabling you to forecast cash flow more accurately and manage working capital effectively.
• Liquidity planning: Understanding DSO allows you to plan for liquidity needs, ensuring you have enough cash on hand to meet short-term obligations.

Credit management

• Credit policy formulation: By analyzing DSO, your business can develop and adjust credit policies to balance sales growth with the risk of bad debts.
• Customer credit assessment: DSO can be used to assess customers' creditworthiness, helping your company decide on appropriate credit terms and limits.

Performance measurement

• Operational efficiency: Monitoring DSO provides insights into the efficiency of your invoicing and collection processes, highlighting areas for improvement.
• Benchmarking: You can compare your DSO against industry averages or competitors to gauge your performance and identify best practices.

Risk management

• Identifying issues: A rising DSO can indicate potential problems with customer payments or economic challenges, prompting early intervention to mitigate risks.
• Bad debt reduction: Regular DSO analysis helps in identifying slow-paying customers, allowing your business to take proactive measures to reduce the risk of bad debts.

Strategic planning

• Business growth: Understanding DSO trends helps you and your team make informed decisions about scaling operations, entering new markets, or extending credit to new customer segments.
• Investment decisions: Accurate DSO analysis supports better investment decisions by providing a clear picture of cash flow stability and operational efficiency.

Financial reporting

• Transparency: Regular reporting of DSO provides transparency to stakeholders about your company’s financial health and credit management practices.
• Investor relations: A stable or improving DSO can enhance investor confidence, as it reflects effective management of receivables and cash flow.

Pricing strategy

• Discount programs: By understanding the impact of DSO on cash flow, your business can design discount programs to incentivize early payments, thereby reducing DSO and improving liquidity.
• Contract negotiations: DSO data can be used to negotiate customer payment terms, ensuring favorable terms for both parties and alignment with your company’s cash flow needs.

Internal controls

• Process improvement: DSO analysis helps pinpoint invoicing and collection process bottlenecks, which can lead to improvements in internal controls and procedures.
• Performance incentives: You can set performance targets related to DSO for your accounts receivable team, aligning incentives with cash flow objectives.

Cost management

• Financing costs: Efficient DSO management can reduce the need for short-term borrowing, leading to savings on interest and financing costs.
• Resource allocation: Streamlined collections free up resources for growth initiatives like sales and product development.

Customer relationship management

• Payment patterns: DSO helps identify customers with consistent payment patterns, allowing for more personalized and effective credit and collection strategies.
• Customer communication: Understanding DSO trends can inform more effective communication with customers about payment expectations and terms.

How to reduce and improve DSO

Now that you understand how collecting accounts receivable can affect your business’s health, it’s time to put a plan in action. Here are eight ways to encourage your customers to pay their invoices and improve your DSO:

1. Invoice customers as soon as you deliver a product or service

Send invoices promptly to ensure timely payments from your customers. You may not always be able to control how quickly customers pay you once they have your invoice in hand. But sending out invoices as soon as possible once you’ve delivered a product or service is one action you can take to improve the speed of payment speed.

2. Use an invoice template that includes your payment terms, due dates, and options

Including information on your invoices like due days, payment terms and options can help keep you and your customers on the same page. Use an invoice template that includes all of these important details, like the invoices generated by QuickBooks’ free invoice generator, or free invoice templates.

3. Automate your accounting system so that you can get alerts when invoices are overdue

Automating the accounts receivable process is simple when you use accounting software that integrates with your payment system and business bank account.

QuickBooks Online makes it easy to track the status of your invoices, from when they’re sent, viewed by your customers, paid, and deposited into your business bank account. Invoices are sorted by status, with overdue invoices listed first, making it easy to see who owes you.

4. Request payment as soon as you notice outstanding accounts

When you discover past-due accounts, take action to remind clients of their overdue payments. Reaching out about past due payments can be challenging and even a little uncomfortable, particularly if your ability to pay your business’s bills depends on incoming cash flow from clients.

Using an invoice email reminder template can help you decide what to say when you reach out. Picking up the phone and giving your customers a call can also speed up the collections process.

5. Review your books and adjust payment terms for clients who pay late consistently

Decide your payment terms carefully. There are many terms you can offer to clients, and if you find certain customers are consistently behind on payments, it may help to shorten your payment terms. You can also consider requiring full or partial payments in advance.

6. Tighten your credit requirements for new applicants

Similarly to decisions about payment terms, you can also make decisions about the credit requirements of your clients. It’s often easier to decide to adjust payment terms based on a client’s credit history before completing any work than it is to deal with collecting from a late-paying client after you’ve delivered the work. A client’s credit history may give you insight on how to adjust your payment terms and credit policies when working with them.

7. Ask for upfront deposits and milestone payments rather than waiting to collect the full balance at the end of the job

Another way to improve your cash flow is to require a deposit before starting work, or to agree payment terms that require progress payments. Both upfront deposits and progress payments, which are delivered based on the completion of a specific part of the work you’re doing for a client, can help you get paid faster for your work.

8. Offer clients more payment options, including electronic payments

Many clients may be accustomed to making payments using a certain method, which can create friction when it’s time for them to pay their bills. Offering a wide range of payment options can help eliminate this common barrier to getting paid on time.