A key metric for knowing how well your receivables collections are doing is to understand the number of day’s sales outstanding that you have in accounts receivable.

This can be a common metric that can equalize variances between different periods in your sales revenue. This allows you to see changes in your levels in receivables relative to the revenues that you can’t just tell by looking at the revenues and the receivables alone.

To calculate this, go as follows:

1. Enter your amount of accounts receivable. This will be the numerator.

2. For the denominator, we’ll get the average daily sales. You’d take your sales for the period, divided by the number of days in the period.

3. Then you divided the numerator into the denominator and the end result will be the number of day’s sales outstanding that you have in accounts receivable. As an example, suppose your accounts receivable was $500,000 and let’s say your sales for the month were $750,000. Normally, we divide the swales by 30 to keep the calculation simple, so that’ll be $25,000 in sales per day. The DSO would be 20 days, which equals $500,000 divided by $25,000.

This is a simple enough calculation, but there is one thing to consider in the decision that could sway your number. If you don’t get this right, you could distort some of the DSO results. The key thing to decide on is what time period will you use for the revenues. Usually, we like to use a large enough period for the revenues that’s greater than the particular receivable balance. That way you’re capturing enough revenues to cover the revenues that trigger the bulk of the accounts receivable.

Otherwise if you don’t do that, you could create some artificial swings in your DSO number. Suppose instead in our above example that the sales for the month were only $250,000. In the calculation, this would come out to 60 days of DSO. However, notice the problem, we took just one month of revenue where the receivables covered about a two month time period. It would be better in the calculation to take the revenue from the past 60 days and then use that to determine the average daily sales during that entire period. (Inaudible) missing if we all use d30 days is that we don’t know how large the revenues were form the previous month. That could have a big impact on the number.

A common flaw that is done in calculating the DSO could be just doing it off of annual numbers. Say you’re doing end of the year calculations and you’re comparing one year to another year for DSO, the problem can be is that the revenues during the year might not have come evenly during each of the 12 months. Sales could’ve been highly concentrated in the fourth quarter or certainly much larger than the quarterly average. If that’s the case, your receivables balance (inaudible) is going to be higher. By doing an annual DSO calculation, this would punish you on the number of day’s sales outstanding and create an artificially high number. But, it wouldn’t be that collections were down, it’s just that there were a lot of sales right towards the end of the year. That’s where we say to have a tight calculation you should look at the last quarter or the last month or two within the last quarter, whatever would fit the situation better.

However, at least having some DSO calculation is a step ahead from none at all. Calculate your DSO and you’re taking one step forward towards better accounts receivable management.