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DSO: why and how to improve DSO?

DSO (Days Sales Outstanding) is an important indicator for managing and improving your cash flow. In this article, we explain how DSO helps you implement an effective and balanced credit risk policy.

What is DSO?

DSO stands for Days Sales Outstanding. Your company's DSO is the number of days invoices are outstanding on average. If you regularly grant trade credit, your DSO is the key indicator that enables you to assess how successful you are in receiving payments on time.

It's important to keep an eye on payment times. Long payment terms can hamper your company's growth. It has a negative impact on your cash flow, forcing you to postpone investments or expenditure.

A high DSO can have several causes. Long payment terms may be contractually defined, for example because they are a condition imposed by a customer with whom you like to do business. A second reason may be that the company needs to be more efficient in collecting invoices. Finally, you may be faced with customers who are unwilling or unable to pay your invoices.

How do you calculate your DSO?

You can easily calculate your DSO using the following formula: DSO = (accounts receivable balance/total sales) * number of days DSO gives an idea of your ability to convert trade receivables into cash. Along with inventories, these receivables are the main component of your working capital. The higher your DSO, the higher your working capital and the lower your free cash flow. Your DSO is therefore an important indicator of your company's financial health.

Example of DSO calculation

In January, Star Fresh Ltd generated sales of €50,000. At the end of the month, the balance of receivables was €35,000.

Average DSO (Days Sales Outstanding)

=

(35 000 / 50 000) * 31 = 21,7 days.

This means that in January, Star Fresh Ltd had to wait an average of 22 days to be paid.

DSO berekenen

What does DSO mean for your company?

It's important that you know how to calculate your DSO, but more importantly, you need to understand what it means for your business. Improving your DSO only makes sense if you take your business strategy into account. Companies or sectors where it's normal to sell on credit will theoretically have a higher DSO.

Like working capital, DSO is not so much a question of value as of variation from one period to the next.

  • Example 1 : Company A sells its products on credit to customers on the domestic market. Invoices are generally paid within 10 days. The company expands its services abroad with a customer who takes longer (about a month) to pay its invoices. Company A's average collection time increases from 10 to 15 days.
  • Example 2 : Company B has a fixed number of loyal customers and grants them a payment term of one month. In recent months, its DSO has stabilized at around 30 days.

Looking at these examples, Company A in particular needs to be careful, despite a lower DSO: its ability to ensure that invoices are paid on time, and therefore its free cash flow, has decreased. Company B, on the other hand, is aware of its average DSO and has anticipated it.

What is a good debtor turnover rate?

You define your company's strategy. With your business strategy, you define a target DSO that corresponds to your company's situation and industry conditions. Consider the following criteria when defining your target DSO:

  • The evolution of your working capital: has it increased significantly in recent months? As a company, can you afford to reduce your free cash flow? Once you've defined your target DSO, you should try to emulate it as closely as possible. And evaluate it regularly, especially as your customer base expands to include new customers or markets.
  • Customer solvency: How well do you know your customers? What is their payment history with you and other suppliers?

Do you want to improve your DSO ? Check the creditworthiness of 3 customers for free now!

A customer who doesn't pay. No fewer than 8 out of 10 entrepreneurs face this problem every year. Fortunately, you can take steps to avoid it. For example, by checking the creditworthiness of your customers. Take our free customer check now and get an assessment of the default risks of 3 customers or prospects.
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