What are days of pending sales (DSO)?
Days of Sales Pending (DSO) is a measure of the average number of days it takes for a business to collect payment for a sale. The DSO is often determined on a monthly, quarterly, or annual basis.
The formula for days of pending sales is as follows: Divide the total number of accounts receivable during a given period by the total value of sales on credit during the same period and multiply the result by the number of days in the period to be is measuring.
Pending sales days are an element of the cash conversion cycle and can also be referred to as accounts receivable days or average collection period.
- Days of pending sales (DSO) is the average number of days it takes for a business to receive payment for a sale.
- A high DSO number suggests that a business is experiencing delays in receiving payments. That can cause a cash flow problem.
- A low DSO indicates that the business is receiving its payments quickly. That money can be reinvested in the business with good results.
- Generally speaking, a DSO of less than 45 days is considered low.
Understanding Hot Day Sales
Given the vital importance of cash flow in running a business, it is best for a business to collect its outstanding accounts receivable as soon as possible. Businesses can expect with relative certainty that their outstanding accounts receivable will, in fact, be paid. But, due to the principle of the time value of money, the time spent waiting to be paid is money wasted.
By quickly converting sales to cash, a business has the opportunity to get cash back to use more quickly.
That said, the definition of “quickly” depends on the business. In the financial industry, relatively long payment terms are common. In the agriculture and fuel industries, prompt payment can be crucial. In general, small companies depend more on stable cash flow than large, diversified ones.
What the numbers tell you
A high DSO number shows that a company is selling its product to customers on credit and waiting a long time to collect money. This can lead to cash flow problems. A low DSO value means that a business takes fewer days to collect its accounts receivable. That company is quickly getting the money it needs to create new businesses.
Indeed, determining the average time that a business’s outstanding balances are carried in accounts receivable can reveal a great deal about the nature of the business’s cash flow.
It is important to remember that the formula for calculating the DSO only takes into account sales on credit. Although cash sales can be considered to have a DSO of 0, they are not included in the DSO calculations. If they were taken into account in the calculation, the DSO would decrease, and companies with a high proportion of cash sales would have lower DSOs than those with a high proportion of credit sales.
Days Sales Outstanding Applications
Days pending sales can be analyzed in a number of ways. It suggests how efficient the company’s collections department is and the degree to which the company maintains customer satisfaction. It also helps to identify clients who are not creditworthy.
Looking at a DSO value for a business over a single period can provide a good benchmark for quickly assessing a business’s cash flow. However, trends in DSO over time are much more useful. They can act as an early warning sign of trouble.
Good and bad DSO numbers
If a company’s DSO is increasing, it is a warning sign that something is wrong. Customer satisfaction may be declining or sellers may be offering longer payment terms to drive increased sales. Or the business may allow low-credit customers to make purchases on credit.
A sharp increase in DSO can cause serious cash flow problems for a business. If a business’s ability to make its own payments in a timely manner is disrupted, it may be forced to make drastic changes.
Typically, when looking at the cash flow of a given company, it is helpful to track that company’s DSO over time to determine if its DSO is trending up or down or if there are patterns in history of the company’s cash flow.
The DSO can constantly vary on a monthly basis, especially if the company’s product is seasonal. If a business has a volatile DSO, this can be cause for concern, but if its DSO regularly drops during a particular season each year, it might not be a cause for concern.
Example of pending sales days
As a hypothetical example, suppose that during the month of July, Company A made a total of $ 500,000 in credit sales and had $ 350,000 in accounts receivable. There are 31 days in July, so Company A’s DSO for July can be calculated as:
With a DSO of 21.7, Company A has an average short term in converting its accounts receivable to cash. Generally speaking, a DSO of less than 45 days is considered low. However, what qualifies as a high or low DSO can vary depending on the type and structure of the business.
Limitations of pending sales days
Like any metric trying to measure a company’s efficiency, days of pending sales come with a set of limitations that is important for any investor to consider before using it.
When using DSO to compare the cash flows of multiple companies, companies within the same industry should be compared, ideally when they have similar business models and revenue figures. Companies of different sizes and in different industries often have very different DSO benchmarks.
When DSO is not so relevant
DSO is not particularly useful for comparing companies with significant differences in the proportion of sales that are made on credit. The DSO of a company with a low proportion of credit sales does not indicate much about the cash flow of that company. Comparing these companies with those with a high proportion of credit sales also says little.
Also, DSO is not a perfect indicator of the efficiency of a company’s accounts receivable. Fluctuating sales volumes can affect DSO, and any increase in sales reduces DSO’s value.
Days Ahead Sales Pending (DDSO) is a good alternative for credit collection assessment or to use in conjunction with DSO. Like any metric that measures the performance of a company, the DSO should not be considered alone, but should be used with other metrics.
Days Pending Sales FAQ
Here are the answers to the most frequently asked questions about pending day sales.
How is the DSO calculated?
Divide the total number of accounts receivable during a given period by the total dollar value of credit sales during the same period, then multiply the result by the number of days in the period being measured.
What is a good ratio of DSO?
A good or bad DSO index can vary depending on the type of business and the industry in which the company operates. That said, a number less than 45 is considered good for most businesses. It suggests that the company’s cash is flowing at a reasonably efficient rate, ready to be used to generate new business.
How is DSO calculated for 3 months?
During the last three months of the year, Company A made a total of $ 1,500,000 in credit sales and had $ 1,050,000 in accounts receivable. The time period covers 92 days. Company A’s DSO for that period is calculated as follows:
- 1,050,000 divided by 1,500,000 equals 0.7.
- 0.7 multiplied by 92 equals 64.4.
The DSO for this business in this period is 64.4.
Why is DSO important?
A high DSO number may indicate that the company’s cash flow is not ideal. It varies by company, but a number less than 45 is considered good.
Better to keep track of the number over time. If the number increases, there may be a problem in the collections department. Or the business may be selling to customers with less than optimal credit. In either case, the company’s cash flow is at risk.
Debt collection experts at Atradius suggest that tracking DSO over time also creates an incentive for the payments department to stay on top of unpaid bills.
It goes without saying that a small business can use the number of outstanding sales from its days to identify and point out to customers who are overwhelming it by not paying immediately.
The bottom line
In many companies, the number of days of pending sales can be a valuable indicator of the efficiency of the company and the quality of its cash flow. If the number is too high, it could even disrupt normal business operations, causing your own outstanding payments to be delayed.
In either case, overdue cash is lost cash for your business.