Sales are great, but cash in hand is what your business needs to function. And how long it takes to turn your accounts receivable into cash is your “days sales outstanding” (DSO), which measures how long does it take for your customers pay their outstanding invoices.
If you haven’t watched your DSO, you’re missing out on a crucial liquidity metric for small businesses.
When your DSO is off the charts, you know it’s time to change direction and avoid upcoming cash flow problems. On the other hand, a low DSO indicates smooth sailing ahead. So what is the DSO sweet spot for your company, and how can you improve your day sales outstanding? Let’s find out.
What is DSO?
Days sales outstanding (DSO) measures the average number of days for invoices to be paid in full. It indicates how efficiently your business collects payments and issues credit.
Is your business efficient at collecting payments and issuing credit wisely? Could your company’s collection or accounts receivable process be improved? Days sales outstanding answers these questions and more.
The lower your DSO, the quicker your credit sales and accounts receivable move into your business bank account, which means you should have enough cash flow to pay your expenses. The higher your DSO, the longer it takes to receive payment, indicating potential cash flow problems.
What does a high or low DSO mean — and why does it matter?
DSO is the make-or-break metric for your company’s cash flow. When analyzing your days sales outstanding, you want to know if the number is high or low. Too high, and you’re in trouble. A low DSO, on the other hand, means you’re in good shape.
Understanding this metric is important because it tells you when there’s a problem with your accounts receivable and credit sales that could impact your future financial health.
When you calculate, analyze, and respond to your days outstanding sales, you can fix the problem before it gets out of hand. But here’s the thing: a high or low DSO isn’t necessarily good or bad. It’s just one important metric that can help you understand the overall financial health of your business.
How to calculate days sales outstanding
To calculate your DSO, divide the total amount of accounts receivable by the total value of credit sales over a certain period (usually 30, 60, or 90 days). The resulting number gives you the average number of days it’s taking for you to get paid.
The days sales outstanding calculation uses three values:
- Accounts receivable: The average accounts receivable balance for the period you’re measuring. This number is the amount your business is owed in outstanding invoices.
- Total credit sales: Your credit sales revenue. That means sales made within the period that isn’t cash sales.
- A number of days: The number of days in the period you’re measuring.
DSO = (Accounts receivable / Credit sales revenue) x Number of days
To calculate DSO, divide accounts receivable by your credit sales revenue. Then multiply by the number of days.
DSO calculation example
Say that you have a B2B company selling IT services and want to calculate your DSO for the year. Your yearly sales are $500,000, and you have $50,000 in accounts receivable. Using the formula:
DSO = 50,000/500,000 = 0.10 x 365 = 36.5
Using the formula, that means your DSO for the year is 36.5. But is that good or bad?
What’s a good DSO for a small business?
The average days sales outstanding varies by industry. The general rule of thumb says that a DSO of less than 45 (and around 30) days is considered good. Once you calculate your DSO, you should track this metric regularly to ensure your liquidity is where it needs to be.
How to improve your DSO
Tracking your DSO regularly will allow you to identify potential issues with your billing or collections strategies, helping you improve your business’s financial health. This could include strategies to encourage prompt payment or reassessing your payment terms. In short, by keeping a close eye on your DSO, you’ll be better equipped to manage your finances, reduce payment delays, and ensure the long-term success and of your business.
If your days sales outstanding are lagging, you can try any of the following strategies to improve your company’s ability to convert credit sales to cash.
- Encourage early payments on invoices with discounts.
- Implement a stricter credit policy and ensure you’re not offering credit to customers with poor credit.
- Find out if your sales teams offer longer payment terms to increase sales.
- Streamline your AR process to make it easier for customers to pay you on time.
Ultimately, the simpler it is for customers to pay, the faster your payments will flow into your business bank account.
Get paid faster with BILL
If you’re looking for a way to streamline your invoicing and payment collection processes, then it might be time to consider BILL.
With BILL, you can automate your invoices, send automatic payment reminders to customers, and simplify payments for regular customers with recurring payments. But the best part is payments go directly into your bank account.
Try BILL today and find out what it’s like to get paid faster.
