DSO is an effective way to determine whether your accounts receivable management is heading in the right direction.
Further, DSO identifies the average number of days to process the accounts receivables into cash, thus giving you a clear picture of the Accounting Department’s efficiency or lack thereof.
DSO becomes meaningful in a number of conditions:
- if it supports and reflects the goals of the department and the company
- if the data are clearly communicated to the individuals involved in payment automation
- if it meets industry standards
- if the DSO is implemented regularly
- if the process makes way for appropriate action from the company.
To calculate for the DSO, here are various formulas:
The standard formula for DSO requires you to divide your ending total receivables by the total credit sales and multiply that by the number of days in the period it took your team to convert the receivables into cash.
Here’s an example of the calculation:
($7000 / $ 14000) x 80 = 40 days DSO
Another way to calculate for the DSO is to divide your current receivables by the total credit sales and multiply the quotient by the number of days.
Should you opt for this best possible DSO formula, you should compare this to the result of the standard calculation as well.
($2500 / $14000) x 80 = 14 days best possible DSO
See if your standard DSO is close to your best possible DSO. The closer the two figures are, the closer your receivables are to the optimal level.
You may also compute for the Delinquent DSO or the Average Days Delinquent.
The Average Days Delinquent DSO shows the number of days your invoices have been past due. To compute for this DSO, subtract the best possible DSO from the standard DSO.
40 days – 14 days = 26 average days delinquent
On the other hand, Countback DSO calculates the fluctuations in your sales and receivables past due. First, count the number of days in the current month. Next, compute for the DSO for the periods before step 1. Subtract the current month’s sales from the month-end net A/R balance. The result is your Prior Periods Receivables.
If the prior month’s sales are less than the Prior Periods Receivables, repeat the first step. The DSO should be greater. Add the DSO for the previous period to the number of days counted back.
The main point of DSO is to ensure that your department is converting A/R into cash in the quickest way possible.
Benchmarking DSO is essential for any company, and though it’s not free, it would be one of the best things that you can do for your department.