With an invoicing software, you can track  payment status, set automated payment reminders to be sent out, and customize your invoices according to individual customers. The additional advantage here is that the invoices have the payment terms (Net 30 or Net 60) and the payment policies of your firm stated on them. In the worst case, you would have to face negative dso meaning cash flow, meaning you may end up taking loans to manage your business finances. On the other hand, a higher DSO value indicates that your firm is allowing a longer duration to receive payments, and worse, your firm is making a lot of sales on credit. Given that John was targeting a 30-day collection period, his DSO of 31 days is good for his business.

Get instant access to video lessons taught by experienced investment bankers. Learn financial statement modeling, DCF, M&A, LBO, Comps and Excel shortcuts. Thus, it is critical to not only diligence industry peers (and the nature of the product/service sold) but the customer-buyer relationship. Recall that an increase in an operating working capital asset is a reduction in FCFs (and the reverse is true for working capital liabilities).

Offer discounts to encourage early payments:

Additionally, leveraging technology for automated reminders and real-time tracking can significantly reduce DSO, improving overall financial health. Accounts Receivable automation assists in all of these areas, making receivables management easier and faster than ever. Properly managing DSO helps your business ensure it has enough cash for day-to-day operations and future growth, marking a well-run company. When you have a shorter DSO, you are able to quickly meet immediate financial obligations like paying salaries, purchasing inventory, and covering operating expenses. A high DSO value illustrates a company is experiencing a hard time when converting credit sales to cash.

So to fully evaluate how well things are working, you often need to consider multiple intersecting data sets. Conversely, if an organization consistently experiences a high DSO rating, it’s probable that there are severe issues with either the firm’s accounts receivable efforts or customer satisfaction. Either way, a higher DSO is a definite choke on the influx of capital to the organization. By calculating these DSO trends regularly, you can use them to tweak and make improvements in your business practices. To get the most out of this metric, it’s recommended to measure DSO periodically, rather than making changes based on individual DSO results. For example, A/R is forecasted to be $33mm in 2021, which was calculated by dividing 55 days by 365 days and multiplying the result by the $220mm in revenue.

Days Sales Outstanding (DSO): Meaning in Finance, Calculation, and Applications

Companies can also extend these criteria to existing customers, starting with those that have been slow to pay. Reducing DSO is not completely within the control of your company’s finance and accounting departments. Therefore, reducing DSO requires not only a focused effort on the part of finance executives, but the cooperation of various departments in the company as well. Below, we outline six simple steps to begin reducing your company’s days of sales outstanding in accounts receivable. With this granular view of accounts receivable process issues (or opportunities), you have the data to quantify their impact on KPIs like your DSO ratio and cash flow.

A higher DSO means it’s taking longer to collect on sales, tying up cash that could be used for other business activities. Conversely, a lower DSO indicates quicker collections and better cash flow efficiency. In many businesses, the days sales outstanding number can be a valuable indicator of the efficiency of the business and the quality of its cash flow. If the number gets too high, it could even disrupt the normal operations of the business, causing its own outstanding payments to be delayed. There are a couple of reasons your days sales outstanding could be trending higher.

What is a Low DSO?

John can remain confident that his accounts receivable process is in good shape. We then multiply 15% by 365 days to get approximately 55 for DSO, which means that once a company has made a sale, it takes ~55 days to collect the cash payment. By giving your customers shorter payment terms, you give them less time to pay their bills. So if payment terms are already very generous, this can be a very easy way to improve your Days Sales Outstanding value. After understanding what days sales outstanding is, we can now move on and explore the purpose of calculating DSO. If a company’s ability to make its own payments in a timely fashion is disrupted, it may be forced to make drastic changes.

• Days sales outstanding (DSO) is one of the best indicators of your business’ well-being.
• Consider factors such as payment processing times, customer creditworthiness, and the efficiency of your invoicing and collections processes.
• But, depending on the type of business and the financial structure it maintains, a company with a large capitalization may not view a DSO of 60 as a serious issue.
• Managers, investors, and creditors see how effective the company is in collecting cash from customers.
• Understanding and effectively utilizing DSO is critical for credit and collections managers to plan their next action items.
• Although accounts receivables and working capital may constitute only a tiny amount of what a public company has on their balance sheet, they may be crucial for smaller companies.
• Several reasons could contribute to customers not paying on time, such as lost bills or incorrect pricing.

If a company’s DSO is increasing, it’s a warning sign that something is wrong. Customer satisfaction might be declining, or the salespeople may be offering longer terms of payment to drive increased sales. Perhaps the company may be allowing customers with poor credit to make purchases on credit.

DSO formula: How to calculate DSO

The shorter the DSO, the faster the company collects payment from its customers – and the sooner it is able to make use of its cash. This formula for calculating DSO is limited to credit sales, and cash sales transactions are usually kept out of it. All you have to do is divide your final accounts receivable by the total credit sales for the period (monthly/quarterly/annually) and multiply it by the number of days in the time period. Use this formula to tell you how many days’ worth of credit sales is tied up in accounts receivable at any given time.

In most cases, a shrinking DSO will indicate more efficient, effective, and lucrative operations. Making smart decisions — like choosing the right automation platform — helps simplify your A/R processes and provides you with direct access to critical KPIs. If you’re offering recurring services, then auto-charging is your best option.