DSO calculation: formula, the countback method and a calculator

What DSO (days sales outstanding) is

DSO is the most widely used indicator of how fast a company collects. A DSO of 60 days means that open receivables are worth, more or less, the last two months of sales. Every day of DSO less frees up cash: with 6 million euros of annual sales, one day is worth about 16 thousand euros of working capital.

DSO is a single number, which is why it should be read together with accounts receivable aging, which shows how past-due balances spread across buckets and customers. DSO tells you how much, aging tells you where.

Standard formula

One rule holds for every variant: numerator and denominator must be consistent. In Italy, trade receivables include VAT, while revenue in the income statement does not. Dividing receivables including VAT by revenue excluding VAT inflates DSO by about 22% for sales at the standard rate: either use sales including VAT, or strip the VAT out of receivables.

The numerator should also exclude receivables that do not arise from the period's sales (advances, other receivables) and, if you want to measure the collection process, receivables sold without recourse, which no longer belong to the company.

The countback method: why it is more accurate

The standard formula divides receivables by average sales. If sales are uneven, the result moves even when customers pay exactly as before: a month of high sales pushes up receivables and therefore standard DSO, even though nobody is paying late.

Countback follows the actual order of the invoices: it starts from the most recent month and subtracts each month's sales from receivables, working backwards, until receivables run out. Months absorbed in full count for all their days, the last one for the share that remains.

• Take receivables at period end.
• Subtract the last month's sales: if receivables are larger, count all the days in the month and move to the month before.
• Repeat until the month's sales exceed the remaining receivables.
• For that month, count the days pro rata: remaining receivables ÷ the month's sales × days in the month.
• DSO is the sum of the days counted.

Monthly and quarterly example

At the end of December a company has 520 thousand euros of trade receivables, VAT included. Sales, also VAT included, were 220 thousand euros in October, 200 thousand in November and 400 thousand in December, a peak month.

The same receivables give three numbers far apart. Monthly DSO underestimates, because it divides by a peak month; quarterly DSO overestimates, because it dilutes December with two weaker months. Countback says what is really in receivables: all of December's sales and 60% of November's, that is 49 days.

The same method gives best possible DSO, calculated on not-yet-due receivables alone. If 380 thousand of the 520 thousand euros are not yet due, best possible DSO is 380 ÷ 400 × 31 = 29.5 days, and the difference, 49.0 − 29.5 = 19.5 days, is the average days delinquent: the part of DSO that depends on customers paying late rather than on the terms granted.

DSO, DPO, DIO and the cash conversion cycle

DSO is one of the three time measures of working capital. Together with DPO (days payables outstanding, the average days taken to pay suppliers) and DIO (days inventory outstanding, the days stock sits in the warehouse) it makes up the cash conversion cycle: how many days pass between paying suppliers and collecting from customers.

With a DSO of 49 days, a DIO of 75 and a DPO of 60, the cash conversion cycle is 64 days: for more than two months the company funds its own business out of its own pocket. Cutting DSO by ten days has the same effect on cash as paying suppliers ten days later, without straining the relationship with them.

What a good DSO is

There is no such thing as a good DSO in absolute terms: it depends on the payment terms granted, which vary by industry, by country and by customer. The useful comparison is between DSO and the average terms weighted by sales.

For business-to-business transactions in Italy the legal reference is Italian Legislative Decree 231/2002, amended by Legislative Decree 192/2012: absent an agreement the term is 30 days, the parties may agree up to 60, and longer terms only if expressly agreed and not grossly unfair. Toward the public administration the term is normally 30 days, 60 in some cases such as healthcare. More than the absolute value, the trend is what counts: a DSO that grows for three months in a row while the aging worsens needs attention right away.

In Muvia, DSO is calculated month by month from the open items and collections copied every night from the ERP, with a query that becomes a dataset with stable fields. When it goes above the target set by management, an episode opens in the alarm register and treasury takes it on: that is the path of the Overdue receivables, aging and DSO use case.

Calculator

Enter receivables at period end and sales for the last three months, VAT included: the calculator returns standard DSO for the month and the quarter, and countback DSO. The starting values are those from the example.