Days sales outstanding refers to the number of business days that a company takes to collect payment after the completion of a sale. This value is an average that is based on the monthly activity in the accounts receivable department. As a financial metric, it only is useful for organizations that receive the majority of their sales against credit accounts. Firms that have a cash business do not have days sales outstanding since payments are received at the time the sale is made.
If the days sales outstanding number is low, it generally reflects an effective and efficient accounts receivable department. Customers are paying their accounts within a short time frame, improving the cash flow of the organization. If this value is high, it reflects how many days the firm is taking to collect the payment, and may highlight issues in the collections or credit granting department.
The calculation for days sales outstanding it the total accounts receivable amount divided by the total credit sales. This value is then multiplied by the number of business days used for the first two values. The answer is expressed in number of business days.
Most firms calculate the days sales outstanding as part of the standard month-end reporting process. It is important to note that this value must be used together with related metrics to obtain a better insight into the business efficiency. For example, the credit-granting criteria used have a huge impact on this metric. If credit is granted without a risk analysis, the days sales outstanding value may be higher, as the customers with credit may be unable to promptly pay.
This calculation is considered one of several key tools used to measure liquidity. For firms that are heavily reliant on accounts receivables, an increase in the days sales outstanding may result in cash flow problems, and clients delay payments. Depending on the severity of the increase and the overall economic climate, an increase may justify an increase in the bad debt allowance.
Many firms report this value on a monthly basis, and look for trends over a period of six to 12 months. It is not uncommon for the values to fluctuate with changes in the business cycle or activity. Typically, it is important to set an upper and lower bound that is acceptable, and to ensure that action is taken if the value falls outside these limits. Careful monitoring of this metric typically is the responsibility of the controller or accountant.
