This is the first of what will be occasional blog entries explaining various financial and accounting terms that business owners and managers may come across.
Like all technical areas, accountancy and finance has it’s fair share of acronyms and odd terms … but when you understand them they can all help get a better understanding of the financial picture of your business. Which at the end of the day is what it is all about.
So our first term is:
DSO
DSO stands for Days Sales Outstanding and is a commonly used measure to understand the amount outstanding as Trade Debtors (amounts owed by customers).
Just looking at the total value of Trade Debtors alone is not a good indicator of the efficiency in collecting the debt or if perhaps there are any trending issues. If you have a good sales month you might expect debtors to rise if your business gives 30 days or more credit. What DSO does is show the value of your debtors as a factor of sales, and therefore it is not influenced by any fluctuations in sales values month by month.
There are commonly two methods of calculating DSO. The simple method is to establish the average daily value of sales (including VAT, as VAT is included in your debtors!) and divide this into the total amount of debtors outstanding. The answer is the average number of days of sales tied up in debtors. If this is then plotted each month the trend in DSO will show if the businesses debtors collections are getting better or worse.
Total Value of Debtors ÷ Average Daily Sales (incl. VAT) = Average Number of Days Sales tied up in Debtors
The more complex method as before but using the most recent months sales first and working back, and therefore getting in effect a more accurate measure than a simple average. However, as DSO is most useful when looking at trends whichever method is used it is consistency which is important.
What might you expect the answer to be? Well that depends a great deal on your agreed credit terms. But as an example lets assume that you give 30 day terms. In reality this often means “30 days current month”, that is to say your customers will pay you 30 days after the end of a month. April sales being paid on 30 May for instance. If your customers paid you bang on the nail on 30 May, then at the end of May you would expect only May’s sales to be outstanding …and therefore your DSO would be 31 days. However, the reality is that payments are likely to arrive during early June …in which case at the end of May you would have both April and May’s sales outstanding and have a DSO of 61 days. Alternatively the answer may be somewhere between the two!
When companies have a member of staff responsible for Credit Control, DSO is a useful measure to judge performance.
