I mentioned how DSO (Day’s Sales Outstanding) can tell how well your collections are doing.  This is typically calculated at the end of the month, usually using 30 days for the days in the period.

            (AR balance / Revenues) * Days in Period

This formula will work fine in the following situations:

• Sales are relatively flat month to month or
• Collections come in rather quickly, so DSO is less than 30 days.

However, if sales fluctuate and collections take longer than one month, then the formula needs to be modified.  The standard formula can magnify changes in DSO and give you a wrong read.

Rather than using 30 days as the period in the calculation, you will need to go farther back, to 60, 90 or 120 days or more.  Go back as far as you need to cover the AR balance.  For example, if the DSO will be between 1-2 months, go back 60 days (two months).  Consider the following example, where I show 2 different ways of doing the roll-back:

	June	July
Current Month Sales	3,000,000	4,500,000
Prior Month Sales	2,500,000	3,000,000
Two Month Sales	5,500,000	7,500,000
AR Balance	4,125,000	5,625,000
DSO- 30 Day Basis	41	38
DSO- 60 Day Basis	45	45
DSO- 60 Day Adjusted	44	41

 

The last two calculations are:

• DSO – 60 Day Basis : (AR balance / Revenues last two months) * 60
• DSO – 60 Day Adjusted : (((AR balance – (current month revenues)) / Revenues Prior Month) * 30) + 30

The basis of the latter calculation is to calculate the DSO for the prior month sales still in AR, then add this to the DSO for the current month (30) to come up with the total DSO.  This is more precise.

Either of the latter two formulas is better.  In times of rising sales, the standard DSO calculation (30 day basis) will make DSO fall faster than it should.  If your DSO is greater than 30 days in the standard calculation, modify it to get a truer DSO each month.