How To Calculate Days Sales In Receivables

In fact, with this, you can find out more about the effectiveness of your accounts receivable processes, particularly credit and collections. As a business, you can understand your cash conversion cycle better if you learn the significant differences between a high and a low DSO. Thus, you should supplement it with an ongoing examination of the aged accounts receivable report and the collection notes of the collection staff. Example of Accounts Receivable DaysIf a company has an average accounts receivable balance of $200,000 and annual sales of $1,200,000, then its accounts receivable days figure is:($200,000 accounts receivable Г· $1,200,000 annual revenue) x 365 daysThe calculation indicates that the company requires 60.8 days to collect a typical invoice. Generally, a figure of 25% more than the standard terms allowed represents an opportunity for improvement.

As a result, this could lead to unstable financial health. A business with high DSO often fails to convert orders to cash, and in some cases, it writes off the payment as a bad debt. This could be because of two reasons вЂ” either the business lacks customers who pay on time or its collections procedure is inefficient. What is a High DSO?In simple words, a high DSO indicates that a business takes more days to collect its dues. Plus, you can significantly improve your cash flow by reducing DSO.

When a business has a low DSO, it also guarantees inflow of operational liquidity that can be used for other high-value functions.Having said that, itвЂ™s not as straightforward as it appears. And that is what leads to a lower DSO and helps a business recover past dues seamlessly. It also indicates that the business has an efficient collections process and a proactive collections team.

In cases where your credit and sales team extend credit without proper risk assessment, it may display a low DSO initially. Relatively high denominator (net sales) value: Ideally, this situation occurs due to a lenient credit policy. ItвЂ™s a sign of good financial health. Relatively low numerator (net receivables) value: This indicates the collections team has effectively collected the dues. This could be because of two reasons:

Offer discounts to early-paying customers:Offering incentives such as discounts or coupons to early-paying customers will improve your DSO. Some of the other strategies to improve DSO are:1. Based on that, you can optimize your collections and credit policies. Nonetheless, DSO calculation should be your natural first step towards improving DSO.

Your accounts receivable team can communicate late fee charges in the terms and conditions so your customers are clear about the penalties. While youвЂ™re at it, ensure thereвЂ™s a penalty policy for late-paying customers too. Also, this helps in proactively sending invoices.

You can also prioritize risky customers to avoid bad debt. Based on the risk level, you can extend your credit. Ensure your collections team is evaluating your customersвЂ™ creditworthiness. However, itвЂ™s crucial to understand whom youвЂ™re getting into business with if a customer consistently delays payments, you must re-evaluate your strategy.

Bad Debt to Sales:Bad debt occurs when customers canвЂ™t pay their dues, and this metric shows how much amount is written off. Acknowledged as one of the best metrics to consider along with DSO, you can interpret the order-to-cash teamsвЂ™ performance. Collections Effectiveness Index (CEI):As the name suggests, CEI measures how effective the collections team and their procedures are. Besides, these factors help the senior management detect error-prone areas and formulate an action plan to eliminate them.1. ThatвЂ™s why itвЂ™s best to consider other factors for a clear picture. ItвЂ™s available for a free download.While DSO calculations help optimize A/R, they still leave room for assumptions.

The period could be three, six, or 12 months. DDO is calculated by dividing the outstanding deductions by the average deductions in a certain period. Days Deduction Outstanding:DDO or Days Deduction Outstanding is a metric calculated to clarify how a business deals with its deductions.

Based on this, the senior management establishes the best method for benchmarking A/R.With the right tool, you can optimize the credit and collections process, thereby improving the DSO. ItвЂ™s theoretically calculated for an internal comparison between the DSO and BPDSO. Best Possible Days Sales Outstanding:This metric defines the best possible number of days it takes for a business to collect its receivables. We recommend aiming for a high A/R turnover ratio as it indicates process efficiency.

How To Calculate Days Sales In Receivables