DSO: The Essential Measure of Accounts Receivable Management Success

A fairly simple measure that is very useful for monitoring the effectiveness of A/R management is Days Sales Outstanding (DSO).  DSO indicates the average age of the receivables, which basically shows the average number of days it takes to collect your A/R.  The lower the DSO the more quickly you convert revenue to cash.   For example, a DSO of 45 indicates a much more effective A/R collection process than does a DSO of 65.  It’s important for you and your financial team* to regularly run “what if” scenarios to better understand the cash flow impact of an increasing or decreasing DSO. 

DSO is calculated as:

D = r / (s1 / 365)

or

D = (r / s2) x 30

where r is Accounts Receivable, s1 is the annual revenue (trailing 12 months) and s2 is the average monthly revenue.  Each formula will give you a slightly different answer because of the number of days used in each, but the difference is not significant enough to cause concern.  The reason both formulas are given here is that in some cases it is more time consuming to determine annual revenue for 12-month periods that cross over two accounting years.  Also, situations where revenue is increasing or decreasing dramatically will often cause the annual revenue number to be less representative of the average than a shorter period that corresponds more directly to the age of the A/R (maybe three or four months).  In cases where the annual revenue is easily determined and is fairly consistent it would be better to use the first formula.  However, in cases where the annual revenue is difficult to determine and/or there are significant revenue fluctuations, it would be better to use the second formula and determine the best average revenue number to use.

The industry in which your company operates will have certain conditions present that influence the ability to collect the amounts billed within a reasonable period of time.  In some businesses a DSO of 60 would be completely unacceptable where in others it would represent an excellent collection rate.  You must establish the appropriate targets for your company and maintain the consistent effort that is required to optimize the cash cycle.

*Explore your options for beefing up your financial team by visiting The Profit Experts.