DSO i.e. Days Sales Outstanding is undoubtedly the most popular KPI in Accounts Receivable and has visibility right from CEO to operational managers. It can be seen as a “High-Impact” metric for monitoring, wherein a small deviation gets noticed along the entire management hierarchy. Incidentally, this KPI is also used by external investors to evaluate financial health of a company. DSO is similar to AR Turnover Ratio wherein it indicates average time taken for the company to collect payments from customers and expressed in number of days.
DSO is derived partially from financial statements for a specific time period and it goes without saying that the measures are semi-additive in nature and time context is mandatory. The formula is very simple and all values are derived for a said period.
DSO = (Ending AR / Total Credit Sales) * Number of days
The key here is “Credit Sales”, which cannot be derived from financial statements, but has to be computed from sales orders booked with different credit payment terms. Numerator indicates the quantum of actual collections made against receivables and denominator indicates the quantum of receivables that were introduced.
For example, for the month ending March-2016, if the AR Balance is $15,000 and Sales was $10,000 the monthly DSO would be 46 days. Assume the quarterly credit sales was $35,000, then quarterly DSO would be 39 days. As you can see, the length of time context can have a considerable impact on the value of DSO and has to be handled carefully because reporting with partial context will convey wrong message to the user.
Since Days Sales Outstanding represents effectiveness and efficiency of Accounts Receivable function in a single KPI, it goes without saying that any AR dashboard is incomplete without DSO.