Days Sales Outstanding (DSO) is an important financial metric for evaluating the effectiveness of converting credit sales (money owed to you) to cash. Considering the time value of money, it indicates the age of an organization’s accounts receivables or AR (sum of all money owed by debtors) in days and the average time it takes to turn receivables into cash. Ideally, this should never exceed the standard payment terms. So for a 52 credit period offered by credit card to borrowers (which is us, debtors to the issuing company), best DSO for the company will be 52. A higher DSO would indicate inefficiency in their collection cycle (and in our payment which they will gladly oblige by slamming exorbitant interest or by delegating collection to recovering agents).
DSO (measured in days) is calculated for a period,
DSO = Accounts Receivables / Credit Sales for the period * 30 (days)
DSO can vary significantly over the course of a year on account of several reasons:
– Fluctuation in sales volume, due to seasonality, economy, etc
– Negotiated payment terms, promotional discounts
Since these situations are common in business, DSO is argued to be an inaccurate indicator of the efficiency of the accounts receivable department. For example, sales surge in a given period with an unchanged overdue balance, will result in a lower DSO. Considering the component of overdue balance in total accounts receivable balance is a better measure of performance of the collection function. Other measures like Delinquent DSO, ADD and CEI consider this.
DSO can be used to evaluate the AR function with industry standards & past performance. It can help forewarn any potential problems in receivables management, rising bad debt (money that will never be paid & will eventually have to be written-off) risks and weakening business conditions (since a downturn usually begins with delayed payments to creditors – people to whom money is owed).
Days Payable Outstanding (DPO) is a similar term to measure payment effectiveness. Everyone in this world thrives to keep this number as high as possible (As individuals, we pay bills on the due date) so as to remain cash rich.
References:
http://www.greenbill.com/2009/03/dso_calculation/
http://www.greenbill.com/2009/03/collection_effectiveness/
http://www.principlesofaccounting.com/chapter%207.htm
http://www.credit-to-cash-advisor.com/Home/Resources/FinancialFormulas/DSOCalculator