Best Possible DSO

Best Possible DSO = (Current Accounts Receivable x 365 Days) / Annual Credit Sales

Where:

• Current accounts receivable is the total of all outstanding sales on credit.

Note: The above example demonstrates a typical best possible DSO calculation, which is performed based on timeframe of one year. However, it is possible to perform this calculation using shorter timeframes as long as the receivables and credit sales are on the same basis.

Accounting and finance metrics allow a company's internal analysts to understand how well its accounting and finance departments are operating. This is usually assessed by examining metrics such as error rates, transactions processed, discounts taken, and turnaround times. Accounting and finance metrics allow the company's management team to identify areas where changes can be made that will improve their key operating metrics. One of the ways to learn about the effectiveness of the company's credit policy and collections process is to calculate its best possible days sales outstanding.

A company's accounting, finance and collections departments are usually responsible for determining the policy that allows customers to make purchases on credit. Once a sale on credit occurs, it is the responsibility of the company's accounts receivable and collections teams to manage the dunning processes which will attempt to collect the dollars owed the corporation. One of the ways to measure the effectiveness of these policies and processes is to measure the company's best possible days sales outstanding. This value is a hypothetical number, which represents the shortest timeframe over which credit sales could have been collected. Typically, a company will calculate this metric to and use it as a benchmark for their collections process. For example, a company's best possible DSO might be 28 days, while its actual days sales outstanding is 47 days.

The CFO of Company ABC wanted to understand how well her collection process was performing. She knew the company's actual days sales outstanding was 51 days, and she wanted to compare this to the company's best possible DSO. She asked her finance team to calculate this benchmark and return their findings to her. Current accounts receivable was $15,300,000, while annual credit sales were $214,800,000. Using this information, the team calculated the best possible DSO as:

= ($15,300,000 x 365) / $214,800,000 = $5,584,500,000 / $214,800,000, or 26 days

Based on the above information, the CFO asked her collections team to present her with options to lower the company's actual DSO by seven days.