Days Sales Outstanding
|1. Definition||2. Formula||3. Example|
|4. Interpretation||5. Analysis||6. MCQ|
|Definition||Days Sales Outstanding (DSO) is the average number of days that a business takes to collect revenue in respect of its credit sales.
DSO is also known as Debtor Days, Receivable Days & Average Collection Period.
Days Sales Outstanding =
|Example||Extracts from the financial statement of HIJ PLC for the year ended 30 June 20X5 are as follow:
|Interpretation||Days Sales Outstanding shows how long it takes for a business to recover the revenue receipts from its trade receivables.
Using the example above, for instance, we can conclude that during the year ended 30 June 20X5 it took HIJ PLC an average of 18.25 days to collect revenue receipts from its trade debtors.
|Analysis||Managing receivables is an important part of the working capital management of a business. DSO is a measure of the effectiveness and efficiency of the credit control processes within an organization in collecting overdue receivables.
A business having DSO higher than the industry average would suggest that it is either offering better credit terms than its competitors (which should lead to additional sales) or that it is simply ineffective in recovering outstanding balances from customers (which would hurt the liquidity of the business unless more favorable credit terms are agreed with the suppliers).
A business with DSO lower than the industry average would suggest a more cautious approach towards its credit policy. While this would improve the cash flows of the business from the early recovery of debts, it could drive sales away from the business towards those competitors offering better credit terms.
Companies should therefore aim to maintain Days Sales Outstanding at a moderate level to ensure a balance between profitability and liquidity.
Test Your Understanding
Following information has been extracted from the quarterly financial statements of ABC PLC:
Any receivables other than trade receivables (e.g. advance to employees, other receivables, etc.) shall be ignored in DSO calculation.
Cash sales and other income should be excluded from DSO calculation.
Number of days should be calculated from the start of the accounting period (i.e. 1 April 2015) until the period end (i.e. 30 June 2015).