Activity Ratios: Receivables Turnover and Days Sales Outstanding (DSO)
Suppose Brent, the owner of a video game store called Gamer's Paradise, is looking at data from the past two years of revenue and average receivables.
| Selected data | Current year | Prior year |
|------------------|--------------|------------|
| Revenues | 130,000 | 100,000 |
| Receivables (end of year) | 11,000 | 10,000 |
Brent knows that the formula for receivables turnover is
$$\displaystyle \frac{\textrm{Revenue}}{\textrm{Average receivables}}$$,
As receivables are paid down faster, the receivables turnover will increase. What is Brent's receivables turnover for the current period?
This month his total receivables were 16,620, and total credit sales were 35,100. What is his DSO?
This is incorrect. Make sure you are dividing A/R by total credit sales, and multiply that answer by the number of days in the period.
Not quite. Make sure you're dividing A/R by total credit sales, and multiply that answer by the number of days in the period.
This is correct! You can see that on an average, it takes Brent 14 days to collect on his accounts. Since this is less than half of the expected collection time, Brent is not having any problem collecting on his receivables.
Keeping in mind that A/R turnover is calculated by dividing revenue by the average of the receivables, what is Robin's DSO?
This is incorrect. Make sure you are averaging the receivables (add both numbers and divide by two), then divide that answer by the revenue.
Incorrect. Check your math here, as this is calculated by averaging the receivables and then dividing this number by the revenue.
That's right!
Robin allowed her customers 30 days to pay and her DSO is a bit above that, so her company needs to do a better job collecting its receivables.
Based on these numbers, what do you believe should be Katie's next step?
No. Katie's DSO is hovering around 30, and although this may not be a cause for alarm, she should watch her DSO for the next few months to see if she needs to make any adjustments to her collection procedures.
This is correct. While these numbers are not a cause for alarm, they do show the DSO is increasing.
In summary:
[[summary]]
The __days sales outstanding (DSO)__ calculation is an activity ratio that shows the number of days it takes a company to convert credit sales to cash. This can be calculated on a monthly, quarterly, or yearly basis. For companies having difficulties collecting receivables, it can even be calculated weekly. The calculation is
$$\displaystyle DSO = \frac{Accounts\: Receivable}{Total \, Credit \, Sales} \times Number \,of \, Days$$.
(Number of days refers to the number of days in the accounting period.)
Not quite.
This is the ratio of average revenues divided by average receivables, but there's no need to take an average of revenues; they are 130,000 in the current year.
Not quite. This uses just current year values, but notice that one of these items comes from the balance sheet; so an average is needed.
Yes!
Brent's receivables turnover for this year can be calculated as:
$$\displaystyle \frac{\text{Revenue}}{\text{Average receivables}} = \frac{130,000}{10,500} = 12.38 $$
To illustrate, suppose Brent allows credit-qualified customers to buy on credit if they promise to pay within 30 days. At the end of each month, Brent calculates the days sales outstanding.
DSO can also be calculated using the following formula:
$$\displaystyle DSO = \frac{Number \:of \:days \:in \:the \:period}{Accounts \:receivable \:turnover}$$.
To try applying this, consider Robin Forrest, who owns a company that sells bow, arrows, and other hunting equipment. She allows customers to purchase items on account with 30 days to pay. At the end of the year, she wants to know how long, on average, it took her customers to pay.
She looks up her financial statements and finds the following (in SGD):
- Receivables as of January 1, 20XX: 1,232,242
- Receivables as of December 31, 20XX: 1,250,718
- Revenue at the end of the year: 14,401,170
Now suppose Katie owns a garden store and sells to both consumers and landscaping or lawn maintenance companies. She allows the businesses to pay within 30 days, since many of them do not get paid by their customers until the job is finished. Lately, Katie has been feeling like she doesn't have as much cash in the bank as she used to. She calculates her DSO for the past six months and finds the following:
- March: 25.67;
- April: 27.73;
- May: 25.85;
- June: 29.60;
- July: 30.77;
- August: 30.54
10.95
11.82
12.38
1.75 days
14.21 days
13.25 days
31 days
51 days
2.5 days
Katie shouldn't worry about it, because these companies probably are just busy in the summer and forget to pay
Katie's DSO is hovering around 30 days, which is not necessarily bad, but she should monitor it closely in the coming months and make adjustments to her collection procedures
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