How to Calculate Days Sales Outstanding…and Why

In this post, you’ll learn about Days Sales Outstanding, one of the key metrics for cash flow. This article covers how to calculate DSO, how to lower DSO and the benefits of doing so.

There are three (3) ways to calculate DSO. Each method has its strengths and weaknesses, as outlined in the handy table below:

Simple or Period-End

This method is easy to calculate, which makes it quite popular. It’s a moment-in-time measure that can help you understand how you’re doing right now. 

The drawback is that it’s subject to change if there’s any spikes or dips in the billing. So a big project, or a large customer making a payment, can skew the numbers a fair bit. If your business doesn’t have a lot of big spikes or dips, you’re probably okay to use the simple method, but for a lot of businesses, there are better methods that account for variability.

Rolling Average

The method is a bit better in the sense that it can smooth over some of the bumps that the simple method doesn’t handle well. However, the rolling average is still subject to seasonality. Again, if that’s not a big issue in your business, this method is probably fine. 

Count-Back Method

Benji Pays recommends the count-back method. It’s the most robust method, working well for both recurring revenue and lumpy revenue. An MSP that has recurring revenue, plus projects, and one-offs, is going to get more value from the count-back method.

The reason more businesses don’t use the count-back method is that it requires manual calculation, which is more time-consuming and probably not all that much fun. 

To solve for this, Benji Pays calculates your DSO using your real data, in real time, using the count-back method. You can track your DSO over time, and always have a reliable view into your cash flow.

Where to Find the Numbers

The numbers you’ll use in any of these calculations can be found in your normal GAAP financial statements. It sounds perhaps obvious, but the balance sheet is a moment in time, so if you’re using sales figures up to the current day, you need to use accounts receivable from the current day as well, not the end of last month or quarter.

Benefits of a Low DSO

The lower your days sales outstanding, the better. A low DSO means that you’re converting sales into cash quickly.

Some of the benefits of keeping a low DSO are:

• You reduce or eliminate the need to use credit for cash flow needs like rent or payroll
• Lower DSO is associated with lower rates of default, and lower default risk
• Cash flow forecasting is easier
• More money to invest in growth
• Greater financial flexibility

How to Lower Your DSO

There’s a few things you can do to lower your days sales outstanding. Here’s some quick wins for you:

Tighten your payment terms

It’s easy to take terms like n/30 for granted. But you don’t have to do n/30, or even n/15. Those terms are basically you extending credit to your clients. There’s times when this makes sense. But even for things where some credit is normal, terms can be tighter. Payment terms aren’t etched in stone; you can always offer a grace period if it’s needed.

Automated payments

For recurring revenue in particular, everybody knows what is due and when. If you’re invoicing for each month on the first day, and collecting at some point later, you can tighten your DSO by sending a reminder before the first day and then automating collection on the first day of the month.

This little shift not only makes for more predictable cash flow but will typically show an improvement of 5-10 days in “average days to pay”.

Automated invoice reminders

Not everybody pays on time, all the time. But chasing late payments can delay payment because let’s face it, chasing late payments is not much fun. Instead of procrastinating, automate a cadence of escalating reminders. This takes much of the dread out of chasing payments, and typically results in reduced time to pay.

One Benji Pays customer lowered their past due invoices from an average of 17.6 days to an average of 3.3 days, simply by automating their invoice reminders.

Impact of Lowering DSO

If you combine the above approaches, you can lower your days sales outstanding considerably. 

For example, if you use automated invoice reminders to lower your past due invoice times by two weeks (17 days to 3 days, as above). But on top of this, you tighten the payment terms from n/30 to n/15. 

The default scenario is n/30 and an average of 17 days overdue. That’s 47 days from when the deal is signed until you get paid.

Improving both gets you to n/15 and an average of 3 days overdue. Now you’re at 18 days from when the deal is signed until you get paid. That’s an improvement of 29 days.

Now you’re getting paid a month faster, on average. What’s that worth to you?

If you’re borrowing money to cover a cash shortfall, that’s a month’s worth of interest on that amount.

$20,000 worth of equipment, on a line of credit for a month at 9.5% is $158.33. 

That’s straight up cash savings.

But when you have your cash for an extra month, you can reinvest it into growing your business. If your internal rate of return in 15%, that’s a gain of $250. 

Making these changes in order to improve your days sales outstanding gives you a net gain of $408.33 on that $20k. 

Now do that every month, for everything that you’re currently selling on credit. 

That’s real money.

If you’re curious why businesses are flocking to Benji Pays, it’s to free up their money like this, in a way that makes a substantial difference on payroll, rent, cash flow, and overall piece of mind. 

Improve your cash flow, improve your life.

Do yourself a favor and book a demo of Benji Pays today.

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