Is Days Sales Outstanding (DSO) Just a Financial Vanity Metric?

When I take on a new client, I generally obtain 60 to 72 months of P&L and balance sheet data.

Among the scores of metrics I blow out from my financial modeling system is DSO, or days sales outstanding. Nearly always, that number is going to hover around 30 days. My focus isn’t on the number per se. I’m looking for trends, positive or negative.

Would you believe I never used DSO to measure my own performance when I worked full-time as a CFO and controller in the W-2 world?

The Detailed Accounts Receivable Aging Is Where the Action Is

In my last CFO job as a W-2 employee, I met with Lisa every Wednesday at 3:00 p.m. for more than one hour going over past-due accounts. We never missed a meeting. If she was out on vacation, another staff member filled in. If I was out, my accounting manager covered my absence.

Each week for each past due, we tried to understand the underlying causes of the payment delays. Every slow-paying account had a story. Accordingly, we would strategize on how to collect those late dollars.

I was somewhat handcuffed in what I could do to strategically prevent past-dues from even occurring. I wanted to keep each customer’s credit card on file and to use it when their account went past due. My bosses, all Board members, would not allow that.

To summarize, my focus wasn’t on DSO. It was watching the aging report like a hawk.

In my Board reporting, I did report DSO (see image below). I also tracked past-dues over 60 days watching for trends, good or bad. Below is an internal report with names and departments hidden.

Here’s a Better Metric to Report

Better may be opinionated, but Goldratt introduced the concept of Inventory Dollar Days in his Theory of Constraints (TOC). We could easily apply the same concept to past-due receivables, or the entire portfolio as he would probably suggest.

The excerpt below only shows 15 hypothetical past-due customer invoices totaling nearly $302,000. What sounds worse? Some $302,000 or more than $11,000,000 in past-due dollar days? Or better yet, how about more than $21,000,000 in total AR dollar days for those same past-dues?

AR Dollar Days Calculation:

Customer account balance times number of days outstanding (example, $2,750 invoice with 87 days outstanding equals $239,250 in AR dollar days). If the focus is primarily on past-due accounts, another option is to only calculate the metric using the number of days past due. In the example above, both calculations are reflected.

Additionally, you can apply the dollar days calculation to all accounts in AR–you just need to find what set of numbers works best in your situation.

Questions to Ponder Relating to Your Receivables

1. Does your accounting department set aside time weekly to collect on past-due accounts? If not, why not?

2. Do you put as much emphasis on an account 5 days past due as an account that is 30 days past due? Remember, an account that is 30 or more days past due was once just a day past-due.

3. Are you putting any focus on eliminating past-due accounts? Or is the focus only on collections of past-due accounts?

4. What metric or flash reporting do you rely on for accounts receivable management? There’s nothing wrong with DSO reporting. DSO reporting is just not the tactical reporting used for collecting those past-due accounts.