Days Sales Outstanding - DSO
Okay, this isn’t a congratulatory missive. Like…“Hey! You had a lot of sales today! Outstanding!” No. Not like that.
Days Sales Outstanding, or DSOs, is a balance sheet computation that puts in perspective how well (or rather, how quickly) you are collecting the bills you are owed for stuff you’ve sold.
Like…let’s say your company, Pulp Friction, is selling paper pulp to the newspaper industry. Gradually, week after week, month after month, quarter after quarter, your DSOs are creeping upward…from 38 days to 53 days in the course of a few years. What is going on here?
Well, if the newspaper industry were financially healthy, it would be reasonable that they would want to pay their bills on time. But clearly there is a trend here. A year goes by, and DSOs are now at 64. This is a bigger and growing problem. The industry is paying for the pulp it consumes to print on paper at a slower rate than they did before. Why?
Well, the newspaper industry is slowly going broke. And they are trying to conserve as much cash as they can by leaning on their vendors to essentially finance them so that they, ya know…die more slowly.
Key takeaway: DSOs are a relative number. That is, in a vacuum…if you just look at one number as a representation of DSOs, it doesn't mean anything. DSOs have to be taken in context of the history of the company itself and in context of whatever the industry average is.
Like...maybe the average DSO of a pulp maker is highly seasonal, and each year it ebbs and flows with the weather. Or maybe your particular pulp company was way better than the norms, and it’s just, uh...normalizing...as DSOs creep back up to the industry standard 64 days. Context.
All right, so the calculation. How do you calculate DSOs? Well, it’s this: Just accounts receivable divided by sales made on credit. And if you’re inside of a large corporation, you can assume that all sales are made on credit. It’s not like a McDonald's store, where USA Today or The Wall Street Journal walks in and hands Weyerhaeuser 14 million dollars in cash for 7,000 tons of pulp.
Think about the equation. It is volatile. And it can turn into a quote good unquote number quickly, by having your pulp selling business turn sour. Like…nobody buys from you for a long time. And everyone pays their bills. All of a sudden, you have a DSO number of like 5 because nobody owes you money in the form of your account receivable. Not a good situation either. Again, DSOs need context.
A huge DSO number can be just fine as well. All of a sudden, China, Russia, and all of Latin America buy your pulp. You suddenly have a billion dollars in accounts receivable and it’ll take you months and months and months to fulfill those orders. So your DSOs then balloon up and…look bad. Most companies would kill to have this "bad" DSO number.
So that’s it. DSOs are just a relative index of how well you are collecting your bills. Receivables over Sales. Outstanding work.