Credit Research Foundation Finds DSO Calculation a Widely Used KPI — Here’s Why
Days sales outstanding, or DSO, is one of the most important key performance indicators (KPIs) your business can measure. This isn’t just a look at the average time it takes for a customer to pay outstanding invoices; it’s a chance to gauge cash flow, financial health and more.
But you don’t have to take our word for it. The Credit Research Foundation (CRF) also has a lot of valuable insight into DSO calculations and why they have such a significant impact.
Read on for an in-depth look at CRF perspectives, DSO calculation requirements and tips for overcoming top challenges.
What Does CRF Say About Days Sales Outstanding?
Days sales outstanding isn’t about any single part of your accounts receivable (AR) workflow or cash flow. It has far-reaching implications, providing insights into factors such as:
- The average time it takes for your company to collect payments.
- Whether your customer base generally pays on time.
- How effective your Collections and Accounts Receivable teams are.
- The efficiency of your overall cash flow.
- The health of customer satisfaction and relationships.
- Your company’s risk appetite, credit terms and invoice processes in comparison to competitors.
As a Platinum Partner with CRF, we recognize their expert definitions and descriptions of KPIs in AR, order-to-cash (O2C) and revenue cycle management topics. DSO is no exception.
Days sales outstanding “expresses the average time (aggregate) in days it takes a firm to convert its accounts receivables to cash.” It’s the standard for AR performance, taught in business schools and accepted in a variety of finance-based communities. CRF notes that this metric is often misused and misunderstood — but, when used properly, it can help determine the root cause of a change in accounts receivable and how that relates to sales.
Although a DSO calculation is considered quick, simple and easy to understand by CRF standards, the foundation also points out that the metric is somewhat limited because it doesn’t account for non-credit sales and other variables.
Countback is a particular method for DSO calculations. As CRF explains, it’s particularly useful for businesses where sales volumes fluctuate significantly from month to month. When you use this method, you’re assuming that “current month sales rather than sales from prior periods” contribute most of your accounts receivable balance.
According to CRF, Countback DSO “mutes the sales bias” frequently caused by monthly sales variability. It also provides a more accurate view of total credit sales vs. cash sales — but it’s somewhat limited if sales don’t fluctuate significantly. For this reason, CRF doesn’t expect it to replace DSO as a particularly widely used KPI.
Best possible days sales outstanding (BPDSO) is considered one of nine key accounts receivable KPIs. CRF calls this a measurement of “the best possible level of receivables,” assuming delinquency never occurs. The idea is to compare DSO and BPDSO; the closer they are, the better you’re doing.
CRF says this metric should always be used in conjunction with DSO. However, it’s important to remember that BPDSO is also limited by its inaccurate reflection of total credit sales, differing terms of sale and other scenarios.
DSO Calculation: Tracking Payment Turnarounds
Every DSO formula is easy to complete, even for staff outside the accounts receivable department. That’s fortunate because performing these calculations is critical to cash flow visibility and management: CRF says, “Knowing what the equivalent of one day represents can help you influence changes […] or fund transformational efforts.”
Here’s how CRF presents the necessary calculations:
You may find many versions of the DSO formula online, but CRF has standardized it in this format:
(Ending Total Receivables x Number of Days in Period Analyzed) ÷ Credit Sales for Period Analyzed
- Ending Total Receivables: Dollar amount representing total accounts receivables.
- Number of Days in Period Analyzed: Measurement of time in a chosen period.
- Credit Sales for Period Analyzed: Dollar amount representing total credit sales.
A DSO of 45 days or below is a low DSO and generally considered average or good. If the result of this calculation is significantly more than 45, you may need to take a closer look, as a high DSO could indicate cash flow and account problems.
Countback DSO Calculation
Countback DSO calculations require a few more steps than the standard DSO formula. CRF breaks it down this way:
- Ending Current Receivables for the period – Credit Sales for the period = Ending Total Receivables for the prior period.
- Ending Total Receivables for the prior period ÷ Credit Sales for the prior period = Percent of Credit Sales for the prior period.
- Percent of Credit Sales for the prior period x Days in Prior period = Days to Add.
- Days to Add + Days in Current Period = Countback DSO.
Note that you can substitute any necessary time frame to make this formula work for your needs. Just be sure to perform the calculations one at a time so you don’t switch the values.
It’s often helpful to compare your days sales outstanding to a best-case scenario, particularly if you have a high DSO. Here’s how CRF recommends calculating BPDSO:
(Current Receivables x Number of Days in Period Analyzed) ÷ Credit Sales for Period Analyzed
This is similar to the standard DSO formula, so remember that this calculation assumes delinquency is non-existent.
Challenges in Days Sales Outstanding Calculations
As you work with the necessary days sales outstanding formula, you may start to realize that, while the calculations make sense on paper, there are plenty of opportunities for things to go wrong. Here are just a few challenges that may render your DSO numbers incomplete or inaccurate:
- Data capture issues: Accounts receivable data can be in a huge variety of formats and locations. Manually capturing this information presents opportunities for human error, which, in turn, leads to inefficiency and accuracy issues. Automated data collection is one of the best ways to overcome these problems.
- Incorrect formula utilization: Although the formulas look simple at first glance, it’s easy to perform calculations improperly or use the wrong data. A small error in your math could create a misleading DSO result.
- Ill-fitting formula: CRF describes many different KPIs, and DSO alone doesn’t tell the full story. If you use this formula without looking at other data or leverage it in the wrong context, you may get numbers that aren’t as relevant as they should be.
- Overlooked variables: Everything from seasonal shifts to large-scale industry disruptors can influence your DSO. If you don’t take these variables into account, you won’t have an accurate view of your cash flow, accounts receivable processes and other elements.
Tips for Lowering Payment Turnarounds
In some cases, you’ve done all the right things and even automated data capture to ensure an accurate outcome, but you still have a high DSO. Fortunately, there are ways to better manage unpaid invoices while still protecting customer satisfaction:
#1: Analyze Available Data
If you aren’t fully leveraging your company’s existing data, you could be missing out on valuable accounts receivable and DSO insights. By identifying the most relevant processes, accounts and invoices and tracking patterns in these areas, you can determine:
- Where inefficiencies come from.
- What might lead to payment delays.
- Which customers represent the most risk.
- How to strategize around higher-risk scenarios.
#2: Reward Early Payment
Discounts and coupons can encourage customers to pay on time or even early. This helps lower your DSO, but it’s not just a numbers game; it goes far deeper than basic calculations to speed up your cash flow, build customer loyalty and even encourage more sales in the future.
#3: Offer Options
Customers have preferences, and if you’re not catering to them, the result could be delayed or outstanding invoices. To avoid this, present your audience with multiple payment tools or platforms. This enables them to interact with your business on terms that work for them, essentially letting them do the work of overcoming efficiency obstacles just by choosing a better payment option.
#4: Review Your Internal Processes
Manual data capture, inefficient processes and disorganized workflows can cause internal delays that ultimately increase DSO. Address these problems through streamlining and automation — especially when it comes to invoice management, O2C activities and AR tasks. Learn more about workflow and collaboration tools.
Lower Your Days Sales Outstanding The Smart Way
There are countless ways to improve your DSO; some are focused on your own teams, while others look at customer relationships and risk management. However, the best DSO solutions combine the best of both worlds — and that’s what you can expect from Carixa’s AR Automation Software.
Ready to get started? Schedule your consultation today.