What is days sales outstanding ratio?
Days sales outstanding or simply Receivable days is an important activity ratio that helps in understanding the efficiency of the company’s operations.
It shows how efficient is the company in managing its receivable balance.
Days sales outstanding meaning
When the company makes a sale of a product or service, it often provides a certain credit period for the buyer to make the payment. Such sales are called as credit sales.
Buyers who purchase goods or services from the company on credit are called Receivables or Debtors.
The money owed to the company by such buyers is shown on the Balance Sheet as “Receivables” or “Debtors”.
Days sales outstanding simply indicate the number of days the company takes to collect money from its debtors on their credit sales.
It explains the credit period policy of the company.
Days sales outstanding formula
Receivable days formula is quite logical.
We take Average Receivables in the numerator and Credit Sales in the denominator and then we multiply by 365.
Average Receivables is nothing but the simple average of receivable balance as at the current period end and previous period end.
Credit Sales are nothing but the sales made by the company to the customers where the money is not collected immediately but after a certain period.
Below aspects has to be kept in mind while calculating the numerator and denominator.
- Any provision for doubtful balances have to reduced from Gross Receivables and Net Receivables has to be considered
- Average Receivables has to be considered and not mere closing Receivables
- Sales refer to the normal revenue the company generates from its core operation.
- We need to consider only credit sales.
- Any goods returned from the customer have to be reduced.
- Hence, Net credit sales have to be considered.
- Sales value should not include any tax amount collected from customers.
- Hence, sales value should be net of any taxes
Let us understand days sales outstanding with a hypothetical example.
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Days sales outstanding example
Let us look at our 1st example.
We take Company A and Company B.
Values given in the examples below are in $ millions.
Consider the below-given income statement for both the companies.
To calculate Days sales outstanding, we need
- Credit sales
- Average Receivables
Credit Sales can be obtained from the Income statement easily.
But, only credit sales have to be considered and not total sales.
- Company A = $1,600
- Company B = $7,00
Now, consider the below-given Balance Sheet extract for both the companies.
Average Receivables can be obtained from the Balance Sheet.
But, note that instead of Gross Receivable, Net Receivables has to be considered.
Hence, any provision for doubtful balance has to be reduced.
- Company A = $100- $20 = $80
- Company B = $150- $30 = $120
Now, let us calculate days sales outstanding for both the companies.
- Average Receivables = $80
- Credit Sales = $1,600
- Days Sales outstanding = ( Average Receivables / Credit Sales ) * 365
- Days Sales outstanding = ( 80 / 1,600) * 365 = 18.25
- Hence, DSO = 18.25 days
- Average Receivables = $120
- Credit Sales = $700
- Days Sales outstanding = ( Average Receivables / Credit Sales ) * 365
- Days Sales outstanding = ( 120 / 700) * 365 = 62.57
- Hence, DSO = 62.57 days
What this indicates is that,
- For Company A it takes around 19 days to collect money from its customers.
- In the case of Company B, it takes as high as 63 days to collect money from its customers.
Hence, Company B is facing difficulty in collecting money from its customers since it takes almost 2 months.
Company A is efficient in managing its receivables since it is collecting money in only 19 days.
Hence, Company A is more efficient in managing its receivables than Company B
Days sales outstanding in excel
In our next example, let us calculate Days sales outstanding for Walmart using excel.
Download the Days sales outstanding template for Walmart using below option.
Below shown is the Consolidated Income Statement of Walmart Inc.
Let us calculate Receivable for Walmart for the year ending 31 Jan 2019
In the case of public companies, it is generally difficult to segregate credit sales from total sales from the reported income statement.
Hence, Analysts generally use total sales as a proxy to credit sales.
Sales value for Walmart can be easily obtained from the income statement.
Sales = $514,405
Now, below-given is an extract from the Consolidated Balance Sheet of Walmart.
Average receivable balance in the case of Walmart can be easily obtained from the Balance sheet.
- Receivable as at 2018 = $5,614
- Receivable as at 2018 = $6,283
- Average Receivable = ($5,614 + $6,283)/2 = $5,949
Now that we know all the values, let us calculate days sales outstanding for Walmart.
DSO = ( Average Receivables / Credit Sales ) * 365
= ( $5,949 / $514,405 ) * 365
= 4.2 days
As evident, days sales outstanding for Walmart is as low as 4.2 days.
What this indicates is that either the company does not offer any credit period or most of the sales are on a cash basis.
Now, let us look at a detailed interpretation of Receivable days in the next section.
Days sales outstanding interpretation
As we have already understood, DSO indicates the number of days the company takes to collect money from its customers.
High days sales outstanding
- Generally, high days sales outstanding indicates that the company is offering a very high credit period on its sales.
- At the same time, it also indicates that the company is finding it difficult to collect money from its customers.
- A very high DSO may indicate that the creditworthiness of the customer is bad and probably the customer is not expected to pay.
- Generally, high debtor days lead to low liquidity.
- This is because the money is currently blocked with customers which could have been used in the operations.
Low days sales outstanding
- Low days sales outstanding indicates that the company is not offering a high credit period on its sales.
- This may also indicate that the Company is able to collect the money timely from its customers.
- Since the money is collected from customers in a short period, it can be redeployed in the operations.
- Hence, low days sales outstanding lead to high liquidity.
Any financial ratios will not give a clear picture when analyzed on a stand-alone basis.
Hence, when analyzing Days sales outstanding, a trend analysis will reveal any unusual situations.
As evident, Microsoft days sales outstanding is 81 days.
DSO has been raising for the past 5 years.
This indicates that either the company is offering a high credit period on its sales or it is finding difficult to collect money from its customers.
Comparison with similar companies
It is also important to track the DSO of various companies in different sectors.
This helps in understanding the cross-sectional industry dynamics.
Walmart vs Home Depot
DSO for companies in the retail sector is generally low.
This is because most of the goods are sold on a cash basis. Hence, no question of the credit period.
In the case of Home Depot – a home improvement retailer ( supplies tools, construction products, and various similar services), you can observe that the Debtor days have been in the range of 7-8 days.
This is similar to what we saw in the case of Walmart.
Both Walmart and Home Depot sell most of their goods on a cash basis. Hence the receivable days for such companies is very low.
This increases the overall liquidity position of the companies.
In the case of Amazon, we can see that DSO is in the range of 18 -25 days.
There was a small decrease during 2015-2016 leading to a better liquidity position.
This indicates efforts taken by the company in better collections of receivables.
But subsequently, the ratio increased back to 25 days.
When you calculate DSO for tech-based companies like Apple, Facebook, Google ( Alphabet) and Microsoft, you will observe that the ratios are relatively high.
In the case of Apple, DSO is in the range of 25 to 30 days.
Compared to companies like Walmart and Home Depot, receivable days for Apple is relatively high.
But such comparison would not be correct since both the companies are into different business models.
It is worthwhile to note that Facebook was able to reduce its DSO moderately from 50 days to the current 43 days.
Although it is not able to decrease the DSO further, it is able to maintain the ratio at around 40 days.
As already highlighted as part of trend analysis for Microsoft, DSO has been increasing gradually.
This indicates the difficulty in collecting the money from customers or the company is deliberately is offering a high credit period on its sales.
Nonetheless, the company has a relatively high DSO among tech-based companies.
Similar to Facebook, even Google has maintained a steady DSO which is in the range of 50 to 60 days.
The revenues of the company are increasing. At the same time, even the Receivable balance is increasing. Hence the company is unable to decrease its receivable days.
Currently, the receivable days for Google is 52 days.
How to increase Days sales outstanding?
To increase DSO, companies may adopt below changes
Increase cash sales
If feasible, companies should make more of cash sales and less of credit sales
Tight Credit Period
Depending upon the type of customer, the credit period has to be changed. Preferably, shorter credit period must be offered to new and infrequent customers
The collection department of the company should try to achieve a timely receipt of dues from the customers. Any huge unpaid balance should be dealt with on a priority basis and try to recover as much as possible.
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