Are your collections getting better or worse?

You could look at your account receivable balance at the end of every month and use that as one benchmark.  That would be fine is your sales level never changed.

But what happens if you had a great sales month?  Your receivables (AR) balance would be up, so by just looking at your AR dollars you could think collections are getting worse.  However, you know that is not the case, since AR climbed because of the rise in sales.

That's why you need a better metric.

This is where DSO (days sales outstanding), is a much better metric.  This compares your AR balance against your sales and brings it back to a common denominator, number of days.  The calculation goes as follows:

            (AR balance / Revenues) * Days in Period

Normally this would be done at month end, so the days would be 30.  For simplicity, usually this is kept at this number rather than changing to 31 days for a longer month (although that would be more precise to change it).

A company that had an AR balance of $3,000,000 and sales of $4,500,000 in a month would have DSO of 20 days that month ((3,000,000/4,500,000)*30).

If the next month AR fell to $2,500,000 but sales fell to $2,500,000 as well, the DSO would climb to 30 days.  While just looking at the AR balance, we could think that AR was doing better since it fell to $2,500,000, the DSO shows otherwise, that collections got much worse.  Had DSO remained the same, the AR should have dropped even more, to $1,666,667.

For looking at quarterly or annual numbers, use 90 or 360 days in the metric.

If your company happens to use a 4-4-5 calendar rather than a month end calendar (where month end closes are set to be at the end of a week rather than the end of a month), then you should change the days to 28 or 35 depending upon the month.

DSO is a key measure of your collections effectiveness.  It can be an early warning sign of collection slow-downs and lead you to take faster action to keep cash flow in line.