DSO or Days Sales Outstanding (also called the average collection period) is a calculation used by a company to estimate their receivables average collection period.  It equals 365 divided by the accounts receivable turnover.

The accounts receivable turnover ratio indicates the number of times accounts receivable is collected during the period. It equals net credit sales divided by the average accounts receivable.

A higher accounts receivable turnover rate reveals faster collections. A very high turnover ratio may indicate a tight credit policy. An increase in the DSO may indicate customer balances becoming noncollectable. This may be the result of selling to highly marginal customers, less collection efforts, unresolved customer disputes or customers paying slower. An increase in DSO can result in cash flow problems. An accounts receivable aging schedule is helpful to understand the composition of the receivables.  The accounts receivable aging schedule will show you the accounts that are getting old so you try to collect them soon.  The accounts receivable aging schedule should be done each month.

Companies should calculate and track DSO every month.  For a monthly calculation, start with receivables and subtract net credit sales until you get to zero. Then add the days of that interval period.

example: June 30 receivables = $200,000

June net credit sales = $120,000, May net credit sales = 160,000

Start with the receivables of $200,000, subtract $120,000 leaving $80,000. Take the ratio of $80,000/$160,000 = 50%.  Multiply May’s 31 days times 50% which equals 15.  So, DSO at June 30 = June’s 30 days plus May’s 15 days which totals 45 days.