The other DSO numbers use the same logic. Here are how the DSO numbers are calculated for March:Ĥ0 =30 days/per month * $400 AR / $300 average monthly salesĤ8 =30 days/per month * $400 AR / $250 average monthly salesĦ0 =30 days/per month * $400 AR / $200 average monthly sales If you’ve been relying on the DSO calculation to monitor the performance of your receivables, this table should set off some very loud alarms in your head. Let’s say that over the course of a year, EG’s sales rise for three months (January, February, and March in the figure below) are flat for three months (April, May, June) fall (July, August, September) and, finally, have a big jump in one month out of three (October, November, December).Īs the figure demonstrates, when we calculate the DSO for those four quarters, the results vary considerably. All of EG’s customers pay on exactly the 45th day after invoicing. To illustrate how this works, let’s take a hypothetical business, EG Corporation. One factor is the variability of your sales the other factor is the time period used to calculate average daily sales. The basic problem with the DSO is that its calculation is influenced by two factors that have nothing to do with how quickly customers pay. Unfortunately, as you’ll see, the problem with the DSO isn’t limited to fast-growing companies. I got this number even though all my receivables were less than 90 days old. One month, in fact, when I used our parent’s mandatory one-year averaging period, my DSO came out to be more than 90 days. And this difference distorts the DSO metric significantly. You can see why our parent, with a growth rate of only 20%, had few problems using a one-year average: There’s only a small difference between the averages for the past 12 months and for the past three months.īut there’s a huge difference when sales grow quickly. If a company offers 30-day terms, and if Receivables are well-managed, most or all of the AR balance is made up of the sales in those green segments.īut if the DSO calculation uses average daily sales over the past 12 months - a value marked by the brown lines for the two different growth rates - then the faster a company is growing, the more inaccurate the 12-month DSO calculation becomes. The dark green line segments emphasize the sales for the most recent quarter for the two different growth rates. As soon as we switched to the longer period, our collection performance looked terrible, as this figure illustrates. Then word came down that AR collection statistics were to be calculated using annual rather than quarterly averages. We were growing at about 100% per year, compared with 20% for our parent, and I’d been basing our DSO reports on average sales over the prior three months. But as I learned many years ago, the standard DSO metric is worse than useless.Īt the time, I was the controller of a small company that had recently been acquired by a public company, and we had to change our reporting practices to satisfy our new parent. Supposedly, by tracking the measure month after month, you see the trend in how your customers are paying their bills. This calculation is intended to give you the average number of days it takes to collect your invoices. Typically, it’s found by dividing your Accounts Receivable balance by average daily sales. The measure you probably use is the “accounts-receivable collection period,” also called the “Days Sales Outstanding in Receivables” (DSO). Using the method is like measuring precision machinery with a rubber band. Unfortunately, the traditional way to measure AR performance is badly broken. During tough economic times it’s particularly important to manage your Accounts Receivable balance carefully.