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Days Sales Outstanding (DSO) is a financial metric that determines the typical time it takes for a business to receive money for a sale or to collect its accounts receivable. It is sometimes referred to as the debtor's turnover ratio or the receivables turnover ratio.
The entire amount of accounts receivable is divided by the average daily net credit sales to determine the DSO. The assets that the business anticipates receiving from its clients or creditors in exchange for the products or services sold on credit are known as accounts receivable. Sales made on credit less sales returns, allowances, and discounts are referred to as net credit sales. The net credit sales are divided by the number of days in the period, which is often a year or a quarter, to get the net credit sales per day.
The DSO formula is:
DSO = Accounts Receivable / (Net Credit Sales / Number of Days)
For example, if a company has accounts receivable of $500,000, net credit sales of $6,000,000, and 365 days in a year, its DSO is:
DSO = $500,000 / ($6,000,000 / 365) = 30.42
This means that the company takes an average of 30.42 days to receive payment for a sale or to collect its accounts receivable.
The DSO is a crucial sign of a company's capacity to manage its credit policy and collection procedure, as well as its ability to manage its cash flow and profitability. It demonstrates how effectively a firm can turn its sales into cash. In contrast to a higher DSO, which suggests that the company is having trouble getting payments and has less cash on hand, a lower DSO indicates that the organization can receive payments promptly.
The DSO, however, is not a conclusive indicator of profitability since it ignores factors such as the credit terms and policies of customers and debtors, as well as the quality, composition, and timeliness of the accounts receivable and net credit sales. As an illustration, certain accounts receivable may not be due right away or may be subject to discounts or penalties, whilst some net credit sales may not be directly tied to the accounts receivable or may change greatly over time.
A more complete and accurate picture of the profitability of the company may be obtained by combining the DSO with other profitability measures such the gross profit margin, net profit margin, return on assets, and return on equity. To evaluate the relative and absolute performance of the company, the DSO should also be contrasted with the average for the industry, the historical trend, and the target or optimal level of the company.
