DSO

What It Is

Days sales outstanding (DSO) is the ratio of receivables to the daily average of credit sales.

How It Works

The formula for daily sales oustanding is:

DSO = Receivables / (Net Annual Sales on Credit / 360)

If a company does not sell on credit (that is, the customer must pay immediately), then total sales is used in the denominator.

For example, let's assume Company XYZ is a department store. If, in 2010, it made $10,000 of its $15,000 in sales on credit, and the 2010 annual report included a balance sheet listing $7,000 of receivables, then using the formula above, we can calculate Company XYZ's DSO:

DSO = $7,000 / ($10,000/360) = 252 days

This means that it took an average of 252 days to collect money on its credit sales in 2010.

Why It Matters

Days sales outstanding (DSO) is important because the speed at which a company collects cash is important to its efficiency and overall profitability. The faster a company collects cash, the faster it can reinvest that cash to make more sales.

Comparing DSO among companies can often give analysts a good idea of which companies manage credit well and use receivables efficiently to grow their businesses. A relatively low DSO indicates that a company collects its receivables quickly, and a high DSO indicates the opposite. Similarly, a company with an increasing DSO over time could be becoming less efficient, while a company with a decreasing DSO over time could be becoming more efficient.

However, changing seasonality in sales can distort DSO. For this reason, some analysts use a daily average of sales based not on the whole year but on 30 to 90 days of sales and use an average receivable number. This does not eliminate the problem of seasonal shifts, but it does mitigate it somewhat.

Regardless, comparison of DSO is generally most meaningful among companies within the same industry, and the definition of a "high" or "low" ratio should be made within this context.

Source: Investing Answers