Understanding your company’s current financial health is essential before implementing new strategies. Key performance indicators (KPIs) such as day sales outstanding (DSO) and accounts receivable turnover(ART) ratio give an overview of your company’s current financial performance.
DSO and ART help forecast cash flow by estimating the duration and frequency of collecting receivables from credit sales. Once you understand the challenges in your accounts receivable (AR) process, you can put in place strategies to improve cash flow. But which is the more important metric to consider – DSO or ART? Should you focus on both the metrics collectively or separately? Read this blog to find out how to use DSO and ART to improve your cash inflow.
Days sales outstanding measures how long it takes for a company to collect its receivables after a credit sale has been made. Many industries use this metric to keep track of their accounts receivables.
The formula for calculating DSO:
If a company ABC makes credit sales worth $50,000 and the account receivables in 20 days is $40,000, then the DSO = ( $40,000/$50,000)*20 = 16. This means that the company takes an average of 16 days to collect its receivables. This can either indicate a low or high DSO considering the company’s payment policy.
A low DSO indicates that the company collects its dues ahead of payment time. A high DSO indicates that the company takes longer to collect its dues than the credit period offered. Ideally, a lower DSO indicates better collection efficiency and a solid credit policy.
Monthly, quarterly and annual assessments of DSO give better insights into the overall performance of your company’s AR team.
Account receivable turnover (ART) ratio measures the number of times a company collects its average account receivables within a term (monthly, quarterly, annual). It is a measure of a companies’ collections efficiency. The higher the ART, the higher is the efficiency of collections.
The formula for calculating ART Ratio:
Average Accounts Receivable= (AR at the beginning of Term + AR at the end of the term)/2
If a company ZZZ has net credit sales worth $3,000,000 and an AR of $200,000 at the beginning of a year and $225,000 at the end of the year, then
Average AR = ($200,000+$225,000)/2 = $212,500
ART = $3,000,000/$212,500 = 14.11
This means that company ZZZ collects accounts receivables ~14 times a year.
To find the account receivable turnover in days, divide 365 by the ART ratio.
For Company ZZZ,
Receivable turnover Ratio in Days (annual ART) = 365/ 14.11 = 25.86
This means that an average customer takes ~26 days to repay the debts. If the company has a strict 30 days payment policy, this ART ratio is within the payment period. Hence, The company has a high accounts receivable turnover ratio, which is good.
|Day Sales Outstanding||Accounts Receivable Turnover Ratio|
|A measure of the average number of days taken to collect the account receivables.||A measure of the number of times an average AR is collected over a period of time.|
|A lower DSO shows higher collections efficiency.||A higher ART shows higher collections efficiency.|
|Low DSO suggests the payments are collected within the due time.||Low ART indicates the company is lacking in collection strategies.|
|High DSO suggests the company is taking longer durations for collecting payments.||High ART indicates the company’s collections and credit policies are efficient.|
|A very low DSO might be a result of lenient credit policies that can cause issues in the long term.||A very high ART might be a result of stringent credit policies that can negatively impact sales.|
Here are some ways DSO and AR turnover ratio help you monitor your AR operations.
Looking at both DSO and AR turnover ratio metrics collectively is crucial. Often, when analyzed in silos, these metrics can be misleading (e.g. DSO values may vary due to seasonal slumps or spikes in sales). Having another metric to cross-examine the insights helps remove errors in your judgment.
DSO and ART complement each other to give you a more rounded picture of your collections efficiency. They help strengthen credit policies to reduce bad debt. These metrics also help gauge customer experience and satisfaction.
Days sales outstanding and accounts receivable turnover (ART) are both performance metrics that help determine your company’s collections process efficiency. Although they are effective alone, analyzing both together provides a complete picture of your cash inflows.
Automating the collections process with effective customer correspondence can help increase the cash flow while minimizing manual efforts. With the eInvoicing and Collections automation solution from HighRadius, you can seamlessly reduce DSO, improve ART, and increase the efficiency of your AR operations.
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