1. The proper way to calculate Days Sales Outstanding (DSO)
2. What the average is in your industry sector.
There are many ways of calculating a DSO figure – as far as I am concerned when it comes to managing your Debtors Ledger on a monthly basis, there is only one.
Before I explain the method of calculation may I explain the concept of DSO for those who may not be that familiar with the concept and for those of you that should be familiar with the concept and could do with a little clarification?
If you said to me my Ledger balance is €600k and asked me if that was good – I couldn’t tell you. I would need to know how old the balances were and what your sales figures were for the past couple of months before I made a decision – would you agree?
Now if you sold €600k last month – and there were 31 days last month, then the balance on your ledger represents the last 31 days sales so your DSO would be 31.
For the purpose of clarification if you said your sales were €200k per month for the past three months, then your ledger represents the last three months sales – and if the last three months were March, February and January, then your DSO would be 31+28+31 = 90.
So if you are to calculate your monthly DSO’s correctly this is what you should do:
1. Start with the total balance of your debtors’ ledger at the end of the month.
2. Subtract the months Gross sales (i.e. including VAT – as VAT is included in your ledger)
3. If sales exceed the balance you have less than one month’s sales outstanding so you should divide the debtors figure by the sales figure – this should give you a number that is less than 1. Multiply that number by the days of the month in question.
4. If the debtors figure exceeds the sales figure, go to the next month and if required the next month until the sales figure exceeds the debtors balance – and when this happens apply step 3. Add up the figures for the full months and the last part month and that is your figure.
What matters here is consistency, you should calculate the figures on the same day, in the same manner every month. Some people say we just count a month as 30 days and couldn’t be bothered with the detail. That’s ok as long as you are being consistent and you are comparing like with like every month.
Some people say “we just take the quarters sales figure – divide it by ninety to find out what one day’s sale is and we divide the Ledger balance by this figure to find our DSO’s.
The problem with this method of calculation is that if you had a higher volume of sales in the last month this will increase your DSO, if your sales dropped in the last month this will decrease your DSO, Using annual figures or even rolling annual figures will have the same effect.
I gather I am talking to credit people, I gather that the credit people (and some accountants) are only interested in DSO figures so we need to make sure we are recording the performance of the collection effort alone and the method of calculation above is the only way I know to make sure this happens.
If you couldn’t be bothered with the sums and just want a spreadsheet that will do it for you – drop me an email to firstname.lastname@example.org and I’ll gladly send it to you.
Finally the second part, every Credit Controller wants to know how they are doing in relation to everyone else, and the truth is that unless you are part of an industry group that shares information – you will never know. If you would like information on these groups or if you would like to set one up in your industry group let me know and I’ll get back to you.
Finally, while DSO’s can be important in some organizations they should never become the sole method of calculating the effectiveness of a credit department – more on this topic in future articles.
Thank you for reading, I hop