Depending on your position in your company, you might see a lot of sales revenue coming into the organization. But when will the the company actually able to use it?
Today’s finance phrase can help you find out.
Days sales outstanding (DSO) tells you how long, on average, it takes for your customers to actually pay you after you invoice them.
The team at Income|Outcome points out why this is important: you need money to run your business on a day-to-day basis.
If cash is slow coming in from your customers, you have to raise that cash somewhere else, such as borrowing from the bank (which is expensive), not paying your own bills (which is dangerous), or putting more of your own money into the business (which you prefer not to do).
That’s why the finance department is always trying to get the sales team to reduce the payment terms they’re giving to customers.
To find your Days Sales Outstanding (DSO) at the end of the year, make a fraction:
Amount customers owe you at year-end / Amount of sales made in last year and multiply that fraction by 365.
For example, if you’ve got $60,000 still unpaid on $360,000 in sales, one sixth of your annual sales is outstanding, or “in Receivables.”
Multiply 365 by that one sixth, and you’ve got your DSO: it’s taking your customers about 61 days to pay you.
Here are a couple of real world examples to help you get your head around this term:
Example: Supermarkets and department stores have very low DSO because customers pay with cash or credit cards, which are reimbursed right away. So as you can see in the image below, Target has 6 days sales outstanding.
Conversely, luxury goods often come with payment plans. So you might expect Harley-Davidson to offer a financing program which would lead to longer DSO.
Looking at their financial statements, you see that Harley-Davidson had a huge amount of Receivables at year-end, giving a DSO of 127 days in 2014.
Different industries have very different structures. But for almost everyone, the goal is to shrink your DSO (unless, like Harley, you make money on financing your customers).
If your average number is 60 days, can you shrink it to 45 days?
If you can, you’re going to reduce those receivables by 25% (and turn it into cash you can use, which is never a bad thing!).
If you’d like to learn more about Days Sales Outstanding, here’s a great article from e2b.