Days Sales Outstanding
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:
|=||Average Debtors||x||Days in accounting period|
Average Debtors represent the average of gross trade receivable balances at the beginning and end of the accounting period.
Gross balance of trade receivables is preferable as it avoids any unnecessary impact of the provisions for doubtful debts on DSO calculation.
e.g. An increase in provision for doubtful debts will have a positive effect on DSO if net trade receivables balance is used even though it is expected to adversely affect the cash inflows.
Credit Sales represent the net credit sales earned during an accounting period as reported in the income statement.
Cash sales should not be included in DSO calculation.
For practical reasons, credit sales are taken net of sales tax even though trade receivables are included at their gross value. Although ideally, sales and debtors should both be included in DSO calculation at their gross values, information normally presented in the financial statements is not sufficient to allocate the sales tax to cash and credit sales.
Extracts from the financial statement of HIJ PLC for the year ended 30 June 20X5 are as follow:
|30 June 20X5||30 June 20X4|
|Cash and bank||15,000||22,000|
Calculate Days Sales Outstanding for the year ended 30 June 20X5.
|DSO =||(50,000 + 70,000) / 2||x 365|
= 18.25 days
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.
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:
30 June 2015
30 June 2014
|Income from sales of fixed assets||2,000,000||-|
30 June 2015
1 April 2015
|Trade and other receivables|
|Trade receivables (gross)||900,000||700,000|
|Less: Provision for doubtful debts||(100,000)||(50,000)|
|Advance to employees||500,000||200,000|
Insert the amounts to be used in the calculation of Days Sales Outstanding for the quarter ended 30 June 2015 below.
|Average Debtors||=||$ + $|
|Number of days||=||$|
|Average Debtors||=||$ 900,000 + $ 700,000|
|Credit Sales||=||$ 8,000,000|
|Number of days||=||91|
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).