# What is the best way to calculate and measure your DSO?

The classic formula of dividing your periodical receivables by your periodic sales/revenue is in my opinion backdated. What do you think and what alternatives did you implement?

**Sort by Date**Sort by Votes

The classic formula has always worked but you need to temper the result by also looking at the accounts payable results. Make sure you are doing both ratios year-to-date as well as for the current month. I also do a comparison to the last 2 prior years. You can see a trend by doing that.

This has been open to debate ever since I worked in Credit Control.

There are many ways, although the most recognised is the "Working back method".

Put Simply it relies on the total (£ Value) Sales Ledge value less the months sales, leaving a balance, deducting the previous months sales, and so on until you reach a point where you have more sales in one particular month but a pro-rata. To demonstrate:

Book Debt cob. 31.03.14 £1 000 000

Sales for 1-31.03/14 - £ 400 000

sub total £ 600 000

Less Sales 1-28.02/14 -£ 350 000

Sub totoal £ 250 000

Sales 1-31-01/14 - £ 500 000

Net over subscription £250 000

250 000/500 000 = 50%

so the last sub total repersent 50% of that months sales. i.e. 15 day or £250 000

So three months worth of sales have taken 2.5 months to pay.

Therefore DSO is represented by the the last two months sales which have been deducted in full, leaving a residual of £250 000, or 50% of the sales for the previous month.

Therefore your DSO is 75 days. That has to be put in to proportion with your terms, which for the sake of argument is 30 days net across all contracts/invoices.

So: 75 -30 (terms)= 45 days over terms.

That is to say you are servicing your book debt against turn over and terms by 45 days over and above those terms.

You can then factor that in to your profit margin.

Where the problem lies with the working back method is when you have variable terms of trade and due date. That is to say, some invoices are due 60 days net (of invoice debt) and others 30 days.

You can use the same procedure above, but would have to put a note to the accounts that you have variable terms and then rationalise the number and value of contracts with either 30 or 60 day terms.

This is best done on a profile basis, particularly when you have a computer programme that can handle various due dates both within the book debt and individual account that makes up the Sales Ledger.

With some systems you can "re-value" the due date of an invoice, by telling the computer that it has terms of 60 days until due. Therefore jn the profile it will stay in the 0-30 day coloumn since technically not due. It will then age in line with the additionall 30 days over its terms.

To that end, what may look like a disastrous DSO of 90 days, once rationalised as above can show that of the 90 days show, actually only 15 days are over terms due to the invoices which have been billed in advance.

This situation occours frequeuntly when you have "mixed terms ledgers" or "Project Ledgers" where the invoicing is billed up front, but payable in installments.

I have founf that where you have large mixed trading ledgers which include projects, you are best setting up two Sales Ledgers:

1. For day to day trading

2. For Contract/stage payment contracts.

These can be consolidated in to the accounts at Balance Sheet level, with a note to the accounts that the terms of sales vary due to variable trading terms.

For the sake of reporting to Managment, you can show the DSO of the daily trading and its profiling as one figure. Then with the other ledger produce a "General Average"; since those projects have stage payment issue and cannot be precisely definded.

Again with the consolidated ledger, you can show the profile in terms of item's due date 0-30, 31-60, 61-90 and 90+

With the ability to re-value the invoice date, so something due to be paid in three months time but billed this month, can be held in the 0-30 coloumn until its true due date falls; i.e. 120 days after issue date when that invoice will then fall in to the 30 day coloumn on the Sales Ledger Profile.

In this case the DSO may come out very high in terms of issue date and final payment date, but with a note to the accounts stating that there are adjustments that need to be taken in to account, and listing the accounts which have variable terms (in the sense of amounts due under the terms of the contract, not general trading) so that these can be rationalised.

Hopefully you will have fixed terms of trade of 30 days net; which makes the whole thing far simpler and as outlined in my opening paragraph about the working back method on standard terms.

There are other methods which you may determine DSO which in part takes account of variable terms, but this usually can only be applied to Year End Balance Sheets.

From the Profit and Loss account, you take the turnover for the year say

£3 650 000.

Divide the turn over by 365 days (giving you an average sale per day of

£10 000 per day

If you book debt is say £ 850 000, then your average DSO would be calculated:

£850 000/£10 000 per day

Therefore average time taken to pay is 85 days.

Again, you would have to put a note to the accounts on the method of calculation i.e. Working back method, or sales on a daily basis; justifying what may appear to be a poor figure but given the various terms better than it would at first appear.

Putting both methods against eachother as comparisons would allow the reader of the accounts to get a better understanding of you true DSO against terms of trade.

I know that it is a long winded explanation, but as I say there is more than one way to calculate DSO, and in particular gets complicated when you have variable trading terms.

The Working back method is easier, again particularly if your systen has the ability to re-age the invoice in perspective with its actual due date. To that end you can provide the aged debt as a ratio of the DSO against book debt.

Do you mean what you wrote--'backdated'--or do you mean 'outdated'? If the latter, please explain why so the rest of us will have some insight into why you apparently object to the traditional way to measure DSO. Thanks in advance.

I still think its a good measurement. Create your target turns to optimize your working capital and cash flow, and measure this on a running annualized, or quarterly basis.

Eg:

Net Credit Sales for period $986,400

Accounts Receivable January 1 $132,600

Accounts Receivable Decenber 31 $124,200

Combined Total $256,800

Average Accounts Receivable $128,400

Turnover Ratio of Accounts Receivable For Period 7.68

DSO is calculated

Total accts receivables / Total sales for the period x Number of days in the period

Days Sales Outstanding (DSO)

Measures the ability to collect from customers.

Accounts Receivable

/ Invoiced Sales in Period (Sales)

=

x Days in The Period

And

Days Payable Outstanding (DPO)

Average Accounts Payable

Cost of Sales

Days in The Period

Days Payable Outstanding

===================================

Days Payable Outstanding (DPO)

Average Accounts Payable

Cost of Sales

Days in The Period

Days Payable Outstanding

Days in Cash Operation Cycle

Average collection period (Days Sales Outstanding)

+ Days sales in inventory

- Days purchases in accounts payable

= Days in Cash Operation Cycle

====================================================

I use a combination of DSO and Days Payables Outstanding to determine the demand on cash flow for business. To measure if your AR is timely, just use an aging report. But the most important metric of your business is cash--so determine how much cash is in the cash cycle of your business, use the above formula.

I also like to prepare an 18-month rolling cash flow to forecast the impact of future transactions on cash. Utilizing a statement of cash flow is a report for reconciling current cash in bank--however, forecasting what the firm's cash position six months from now is a more definitive measurement.

Best Possible DSO utilizes only your current (non delinquent) receivables to calculate the best length of time you can achieve in turning over receivables. It should be compared to the standard calculation above, and be close to your terms of sale.

The closer your standard DSO is to your best possible DSO, the closer your receivables are to your optimal level.

Best DSO Formula and calculation utilizing data above:

(Current Receivables / Total Credit Sales) x Number of Days

($3,000 / $16,000) x 91 = 17 days Best Possible DSO