Definition:

Days of Sales Outstanding (DSO) is a financial metric that measures the average number of days it takes for a company to collect payment after a sale has been made.

Formula:

DSO = (Accounts Receivable / Total Credit Sales) * Number of Days

How to use the metric:

DSO is used to assess a company's efficiency in collecting its receivables. A lower DSO indicates that a company is collecting its receivables quickly, which is generally positive for cash flow. Conversely, a higher DSO suggests slower collection, which may indicate potential cash flow issues or lenient credit policies.

Limitations:

DSO can be influenced by seasonal sales fluctuations, making it less reliable if not analyzed over a consistent period. It also does not account for the quality of receivables, meaning it doesn't differentiate between receivables that are likely to be collected and those that are not.

Applies to:

DSO is particularly useful in industries with significant credit sales, such as manufacturing, wholesale, and retail, where managing receivables is crucial for maintaining liquidity.

Doesn't apply to:

DSO is less applicable to industries with minimal credit sales, such as cash-based businesses or sectors like utilities and telecommunications, where payments are often received upfront or through automated billing systems.

Summary:

Days of Sales Outstanding is a key metric for evaluating how efficiently a company collects its receivables. While useful for assessing cash flow and credit policies, it has limitations, such as susceptibility to seasonal variations and lack of insight into receivables quality. It is most relevant in industries with substantial credit sales.