Days' Sales Outstanding (DSO) Ratio

Days' sales outstanding ratio (also called average collection period or days' sales in receivables) is used to measure the average number of days a business takes to collect its trade receivables after they have been created. It is an activity ratio and gives information about the efficiency of sales collection activities.

Formula

Days Sales Outstanding is calculated using following formula:

DSO = Accounts Receivable × Number of Days
Credit Sales

If possible, use the average accounts receivable during the period.

Another formula which uses the accounts receivable turnover is:

DSO = Number of Days in the Period
Accounts Receivable Turnover

Analysis

Since it is profitable to convert sales into cash quickly, which means that a lower value of Days Sales Outstanding is favorable whereas a higher value is unfavorable. However it is more meaningful to create monthly or weekly trend of DSO. Any significant increase in the trend is unfavorable and indicates inefficiency in credit sales collection.

Examples

Example 1: Calculate the Days Sales Outstanding from the following information:
Net Credit Sales during the month: $644,790
Average Accounts Receivable during the month: $43,300.
Calculate the receivables turnover ratio.

Solution
Days Sales Outstanding = ( $43,300 / $644,790 ) × 30 days = 2.01

Example 2: Following is the trend of DSO for β company for past 6 months:

MonthDSO
013.10
023.13
033.48
043.95
054.16
065.31

Question Is the average collection period for β Company improving or deteriorating?

Answer
The average collection period has a deteriorating trend.

Written by Irfanullah Jan