Receivables Turnover versus Days Sales Outstanding
Tracking performance of an Accounts Receivable team is done, in part, by assessing key performance indicators (KPIs). Since cash flow is necessary for operations, collecting what’s owed to your organization is a vital activity.
Two critical KPIs that can help you track and optimize collection activities are Days Sales Outstanding (DSO) and Accounts Receivable Turnover (ART). These indicators are variants of each other and are important to track simultaneously.
What is DSO?
Days Sales Outstanding is a ratio that measures the number of days, on average, it takes your company to collect from your customers and clients. Calculation inputs are the ending accounts receivable balance for the period and credit sales for the same period.
DSO = [(AR / credit sales) x days in the period]
What’s a good DSO ratio?
The lower the Days Sales Outstanding ratio, the faster you’re collecting on your accounts receivable. However, too low of a DSO could indicate that your credit policies are too strict, and as a result, you may be missing sales opportunities.
A high DSO could suggest your credit policies are too lax, your collections process is flawed, or invoices are going out late or with errors. Acceptable DSO depends on your industry. For example, mining and construction have higher DSOs than agriculture and textiles.
Problems with DSO
Setting a target DSO that’s relevant to your industry is imperative. If your DSO is 1.5 times your usual credit terms, that’s a sign of departmental effectiveness (for example, net 30 terms x 1.5 = target DSO 45 days). DSO doesn’t consider seasonal shifts or industry norms.
Know that DSO can radically drop even when your business is doing well. If sales spike and exceed AR, it can throw off your DSO. Conversely, in a standard seasonal sales slump, AR can be overwhelmingly higher, throwing DSO off in the other direction.
What is ART?
Accounts Receivable Turnover is a ratio that measures how many times you collected your AR during a certain period, and measures the efficiency of your credit and collection efforts. The data needed to determine the calculation is revenue from the period and the average AR.
ART = net credit sales / average AR
Average AR = [(Beginning AR + Ending AR) ÷ 2]
What’s a good ART ratio?
The higher the ART, the better, as it shows the frequency at which you collect your average AR during the year. Higher implies greater liquidity and cash flow. To understand the number better, divide 365 (days in the year) by your ART ratio.
If your ART is 5, you are collecting on credit sales every 73 days (365 ÷ 5), on average. If your terms are net 15 or 30, that many days turnover looks problematic. As with DSO, a good versus bad ART varies by industry and credit policies.
Problems with ART
With this KPI, the number itself doesn’t offer the totality of insight you need. The weakness of ART is that you know how many times during the period you’re collecting your receivables, but not “why.” Your credit policies may be too lax or strict. Also, ART is typically crunched annually, and you need actionable insight more frequently than that.
Why should you track both DSO and ART?
Used together, DSO and ART offer a more complete picture of the effectiveness of your team in collecting payments due. DSO is helpful to calculate monthly, quarterly, and annually, while ART is considered annually. Using both together provides immediate data and a historical measure.
Who’s responsible for DSO and ART reporting?
The Accounts Receivable manager or department head oversees the team that tracks AR activity and monthly reporting and calculates KPIs such as DSO and ART. Integrity of these calculations is vital even if they’re unfavorable to the team.
Tracking KPIs is informative, but crunching the data takes time that could be spent invoicing and collecting. An automated tool that provides the metrics in a constantly up-to-date dashboard saves time and frees staff to focus on core functions.
Ultimately, AR collections and reporting are the responsibility of the CFO and leadership team. To learn more about how your organization can radically improve AR collections performance and provide better visibility across the organization on these metrics, read our DSO guide, and then schedule a demo today.