To calculate your DSO ratio, divide your accounts receivable by your annual average sales per day.
DSO = (total receivables at year end / total annual credit sales) x 365 days
An alternative DSO formula focuses on your current account receivables and gives a more accurate picture of your DSO at any given moment.
DSO = (current accounts receivable / total credit sales) x number of days
Days sales outstanding ratio analysis
These equations are the most common methods for calculating days sales outstanding used by businesses as a KPI today. However, whether these represent good days sales outstanding ratios is the subject of much debate. A criticism of these methods focuses on the fact the DSO ratio only gives an average and doesn’t distinguish between prompt and tardy payments. It also doesn’t accurately reflect fluctuations in payment behaviour, whereby one customer may pay promptly for one invoice and delay paying the next.
An important benefit of calculating and monitoring DSO is that it encourages businesses to stay on top of unpaid invoices. It is a good credit management technique and can be used to help businesses determine credit policies and as a reminder to chase overdue payments.
What is the best DSO ratio for your business?
The best DSO for your business depends entirely on your business, your sector, your geographical location and cash flow, and is likely to change over time. In some regions, such as Scandinavia, prompt payment is a cultural expectation and DSO tends to be fairly low. There is also a variation in average DSO between sectors, with the finance sector usually applying fairly long payment terms and the agri-food and fuel sectors usually operating short payment terms. The most appropriate DSO for your business will include payment terms and payment collections processes that ensure a healthy cash flow, while making sure your business remains attractive to customers and competitive within your market.