Metric of the Month: DSO
“The first rule is that a measurement, any measurement, is better than none.” — Andy Grove
This will be a new monthly series as part of our regular newsletter. There are too many financial metrics and most articles are long on definition, short on “what do I do with this?”
This series will fix that. What we’ll cover:
- Metric overview (what it is and why it matters)
- Who should care about it
- What actually moves it
1) Days Sales Outstanding (DSO)
Long-time followers and fans have been beaten-over-the-head with this metric, but what better place to start than deep in the belly of working capital.
DSO = average collection period of sales for your business in aggregate
It’s a critical metric, especially for businesses regularly invoicing customers (i.e. virtually everyone except for maybe retail/e-commerce).
To calculate it:
- Pick any 12-month period of sales (doesn’t have to be December)
- Compute your “receivables turnover” = 12-month sales ÷ A/R
- DSO = 360 ÷ receivables turnover
- If you’re seasonal, use average A/R from the last few months to smooth results
Example: $1,000 sales and $100 A/R = 10x… 360 ÷ 10x = 36 days. Simple.
2) Who should care?
Everyone. A single day of DSO is cash trapped on your balance sheet. For a $1m business with $100k A/R, a single day is worth close to $3k!
Allow this to go unnoticed and it could cost you tens of thousands over time. The longer your typical invoice terms (net-30 or longer), the more crucial this metric becomes.
You want to compare your actual performance (DSO) against your stated invoice terms (i.e. net-30). This gap between actual DSO and stated terms will dictate which strategies you use to close it.
For example: if you ask for payment in 30 days and get paid in 30 days, then you don’t want to incentivize customers with early pay discounts. If those customers pay in 50 days (i.e. 20 days late on average), then early pay discounts might be a good tactic to close the gap.
A few exceptions for tracking DSO would be: full cash basis (rare), e-commerce, or a brick-and-mortar retailer.
3) What drives this metric?
Sales and receivables are the inputs here. Let’s look at a real company in the commercial lawncare industry:
Their DSOs were hovering around 65-67 for months, then spiked to 72-75. Translation: cash flow got worse the past 3 quarters.
So how do we use this information?
- Set a “normal” range for your business — the above example might have a normal range of 65-70… anything outside that would warrant investigation into A/R aging, collection processes, isolated customer issues, etc.
- Read the trend, not just the number — a few consecutive months or quarters of rising DSO might indicate problems.
- Score your customers — calculate DSO by customer to see your good-paying VIP customers vs. potential headaches, prune the latter group.
- Stress-test growth — use your real DSO to see if you can afford adding crews, trucks, or locations without running out of cash.
- Compare segments — find your DSO by service line, job type, or sales channel to decide where to push sales and where to tighten terms (not all streams pay equally).
- Add to a scorecard — track it on your ratio scorecard and use your “normal range” as a goal.
- Trigger collections — watch for rising DSO by customer and call those accounts before they hit 60+ days.
- Set “no more work” thresholds — use DSO and days past due thresholds to pause work or require deposits from slow-paying customers.