Days Sales Outstanding

Definition of Days Sales Outstanding

The term “days sales outstanding” refers to the average number of days a company takes to collect the receivables after selling them on credit. In other words, the metric assesses the ability of the company’s collection department and the negotiating power of the company among its customers. It is also known as “average collection period”, “day’s sales in receivable” and “accounts receivable period”.

Formula 

The formula for days sales outstanding can be derived by dividing the average accounts receivable for the period by the net credit sales of the same period, and then it is multiplied by 365 to express it in terms of days. Mathematically, it is represented as,

The average receivable is the mean of the receivable at the start of the year (opening receivable) and at the end of the year (closing receivable). The net credit sales simply mean sales that were executed, not credit. However, if details about net credit sales are not available, then it is advisable to use the entire sales as a proxy for net credit sales.

Average Receivable = (Opening Receivable + Closing receivable) / 2

Examples of Days Sales Outstanding (With Excel Template)

Let’s take an example to better understand the Days Sales Outstanding formula calculation in a better manner.

Example #1

Let us take the example of a company named MNB Ltd, which is engaged in manufacturing furniture in the state of North Carolina. The promoter wants to have some idea about the current credit policy of the company. Calculate the day’s sales outstanding to help the promoter. Use the following information:

Solution:

Average Receivables is calculated by using the formula given below

Average Receivable = (Opening Receivable + Closing receivable) / 2

• Average Receivable = ($160 million + $180 million) / 2
• Average Receivable = $170 million

Days Sales Outstanding is calculated by using the formula given below

Days Sales Outstanding = Average Receivable / Net Credit Sales * 365

• DSO = $170 million / $500 million * 365
• DSO = 124 days

Therefore, MNB Ltd.’s day’s sales outstanding for the year stood at 124 days.

Example – #2

Let us take the example of Walmart Inc.’s latest annual report (2018) to demonstrate the calculation of the day’s sales outstanding. As per the annual report, the company registered net sales of $495,761 million, while the opening receivable (net) for the period stood at $5,835 million and the closing receivable (net) stood at $5,614 million. Calculate the day’s sales outstanding of Walmart Inc. for the year 2018 by using the given information.

Solution:

Average Receivable is calculated by using the formula given below

Average Receivable = (Opening Receivable + Closing receivable) / 2

• Average Receivable = ($5,835 million + $5,614 million) / 2
• Average Receivable = $5,724.5 million

Days Sales Outstanding is calculated by using the formula given below

Days Sales Outstanding = Average Receivable / Net Credit Sales * 365

• DSO = $5,724.5 million / $495,761 million * 365
• DSO = 4 days

Therefore, Walmart Inc. collected its receivable in 4 days during 2018.

Source: s2.q4cdn.com

Limitations of DSO

Some of the limitations of DSO are:

• The metric is not very useful if it is used for comparing companies whose proportion of credit sales differ significantly. This means that it is difficult to infer anything of significance by comparing a company with a low proportion of credit sales does to a company with a high share of credit sales.
• It is also not the textbook indicator of a company’s accounts receivable efficiency because the metric is impacted by fluctuating sales volumes, such that any increase in sales will result in lower day sales outstanding.
• The calculation is based on receivables at the start and at the end of the year. As such, for businesses characterized by peak season in the middle of the year, the metric may fail to depict the true picture as the calculation uses values that are as on the balance sheet date.
• Another flaw is that if there is no clarity about the proportion of credit sales, the entire sales are considered the net credit sales. Such proxy frequently results in an understated value that is not correct.

Important Points to Note about Days Sales Outstanding

Some important points about the DSO are:

• The metric indicates how quickly the customers pay their dues or how the collection department of the company works.
• It can be used as a good benchmark for assessing a company’s cash flow. However, it is advisable to monitor the trends in days sales outstanding over a period of time.
• A lower value for DSO is seen as a positive as it indicates that the company is able to collect the receivables quickly. On the other hand, a higher value may be a sign of weak credit policies, which can be seen as a matter of concern. The reason for higher value can be that customers are taking more time to pay, or the salespeople are offering longer terms of payment to drive increased sales.

Conclusion

So, days sales outstanding is another liquidity metric used to determine how quickly a company can collect the receivables. It is important for financial analysts to understand the concept of DSO as it is a crucial part of the working capital assessment.

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