Days Sales Outstanding

Days Sales Outstanding (DSO) is a financial metric that measures the average number of days it takes a company to collect payment from its customers after a sale has been made. It is an indicator of the effectiveness of a company's credit and collection policies and helps assess how efficiently a company is managing its accounts receivable.

To calculate Days Sales Outstanding, use the following formula:

DSO = (Average Accounts Receivable / Net Credit Sales) × Number of Days in Period

Where:

• Average Accounts Receivable is the average value of the accounts receivable during the period, usually calculated as the sum of the beginning and ending accounts receivable values divided by two.
• Net Credit Sales represent the total sales made on credit during the period, excluding cash sales.
• Number of Days in Period refers to the number of days in the accounting period, typically 365 days for a year or 90 days for a quarter.

For example, if a company's average accounts receivable is $4 million, its net credit sales for the year are $16 million, and there are 365 days in the year, the DSO would be:

DSO = ($4,000,000 / $16,000,000) × 365 = 91.25 days

This means it takes the company an average of 91.25 days to collect payment from its customers after a sale has been made.

A lower DSO indicates that a company is collecting its receivables more quickly, which can improve cash flow and reduce the risk of bad debts. A higher DSO suggests that the company takes longer to collect payments from its customers, which can tie up cash and potentially signal credit and collection issues. It's important to compare a company's DSO with industry benchmarks and track its DSO trends over time to assess its performance in managing accounts receivable.

Days Payable Outstanding (DPO)

Days Payable Outstanding (DPO) is another financial metric that measures the average number of days it takes a company to pay its suppliers after receiving an invoice. It is an indicator of a company's cash management and payment practices and helps assess how efficiently a company is managing its accounts payable.

To calculate Days Payable Outstanding, use the following formula:

DPO = (Average Accounts Payable / Cost of Goods Sold) × Number of Days in Period

Where:

• Average Accounts Payable is the average value of the accounts payable during the period, usually calculated as the sum of the beginning and ending accounts payable values divided by two.
• Cost of Goods Sold (COGS) represents the total cost of producing the goods or services that were sold during the period.
• Number of Days in Period refers to the number of days in the accounting period, typically 365 days for a year or 90 days for a quarter.

A higher DPO implies that a company is taking longer to pay its suppliers, which can be beneficial for the company's cash flow, as it allows the company to use the cash for other purposes in the meantime. However, a too high DPO could indicate potential issues with the company's liquidity or its relationships with suppliers. A lower DPO suggests that the company is paying its suppliers more quickly, which can be favorable for supplier relationships but may also indicate less efficient cash management. As with DIO and DSO, it's essential to compare a company's DPO with industry benchmarks and track its DPO trends over time to assess its performance in managing accounts payable.