DSO Calculation Methods - What Are The Best Practices?

Brett Bennett's Profile

DSO Calculation

Wondering what your company's best practices and methods for calculating DSO?  Currently, our company includes unbilled revenue or amounts from sales contracts that have been signed but no revenue has been generated yet.  It appears this is skewing the calculation.  We also only invoice customers at month end.  When calculating DS during the month, our DSO calculation methodology is all over the board.  Wondering any best practices for including/excluding unbilled revenue and calculating inter month DSO when invoices are not generated until month end?  Thank you.

Answers

Member's Profile

Well, the fact that you only send invoices at the end of the month is a major factor in this. To say nothing of the very real delay this causes in your receivables. To wit (and I'm sure you realize this), the same invoice you could send on the 1st of the month gets delayed to the 31st, thus adding 30 "shadow" days to your receivable and increasing your DSO. That's just the CFO in me twitching :).

Interestingly, by excluding unbilled revenue one would think that you would remove the measurement bias of your once-monthly invoicing behavior. And that so long as you used this to understand your DSO of only billed customers, you should be in good shape.

However, heeding the CFO in me again, I would say that only measuring based on billed customers will likely lead to confusion amongst management b/c the constant question will be "wait, have we billed them yet...?", or simply "okay, which of our deals does this DSO assumption cover?" My two cents (and I may owe you some change) would be to increase your billing frequency and use a DSO calc that includes all closed deals, knowing that you don't need to carve any deals out of the calculation. IDK whether that is a "best practice", but it seems like it would a)reduce your overall DSO, b)increase your cash flow (rarely a bad thing) and c)make DSO a more broadly understood and therefore more meaningful measurement within your company. Hope that helps.

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Member's Profile

Yes, Bryan, that can add a tremendous amount of time.

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Best... Sarah

Enjoy!

Best... Sarah

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Member's Profile

I must agree with many of the comments by Bryan - especially the twitchy ones:).
Perhaps a refinement of his idea is to see if you can gather two sets of data consistently: Actual Billings per month (NOT revenue recognized), and Month-end totals for Unbilled Amounts on Signed Orders.
My reasoning: 1. First metric:calculate DSO on AR and Actual Billings. Use the reduction method where each month's billings = 30 days of AR.
2. Track the trend on Unbilled Amounts.
Then compare this with (a) the DSO above and (b) the Monthly total of new orders booked.
That way you can show your execs:
1. DSO efficiency-cash collection efficiency
2. Unbilled amounts - billing efficiency on signed deals
3. New business booked-sales efficiency in signing new deals

Out of that you may be able to see if any processes need improving:)

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Member's Profile

Comments by both Brian and Len are terrific. My experience is that inclusion of unbilled AR in your DSO calculation methods will sway the days, especially if your billing of new contracts is erratic which it probably is. I have had two calculations, one using billed AR and one using unbilled AR. I found that if you invoice and collect routinely, the billed AR DSO will remain largely range bound. Good luck!

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Thank you everyone for your comments, I am in agreement as well. Twitch Twitch. Ross, would you be able to share your billed AR and unbilled AR DSO calculations? Again, thank you very for expert comments and suggestions.

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Member's Profile

Brett, Do you know if there was any reason why your company chose to use this measurement for collection performance? Different compamnies may use different methodology depending on their access to measurement data and other preferences, for example, analysts may look at DSO based on quarterly average days sales if that information is publicly available, whereas internal data may be used to calculate DSO based on lifo or monthly average days sales.

The important thing is that users understand how the data is calculated, what it means, and most important, are able to monitor and explain changes in the trends.

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Member's Profile

If your revenue is unbilled because you have not "earned" it, then your results will really be skewed. Then your contract to recognized revenue to billed revenue delays can cause big swings in addition to only billing at month end. From a cash flow perspective, are you able to bill throughout the month?

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Member's Profile

Brett,

Although DSO is a widely accepted metric used in assessing collection effectiveness/capability/performance (as noted above in a few responses), it merely reveals how long it is taking for your customers to pay you. From there, you must employ additional metrics to determine if a high DSO is perhaps caused by (a) pressures/circumstances your customers are facing (economy?), (b) your own internal collection performance (most widely associated issue), (c) some other factor(s) and (d) some combo of the above.

So my suggestion is to think beyond what your eventual DSO calc reveals... don't just conclude that a high number means your team is doing a bad job.

If you get an unacceptably high number, yes, I agree, you should first measure what you control: your collection team and your collection process/policies. So implement additional metrics that show your performance there. For example, you can take the AR Trial Balance and compare the frequency of calls the team makes to the 'Over 30' bucket vs. the 'Over 60" vs. the 'Over 90', etc. Assuming you have a Collection Department policy requiring X number of calls per month to each bucket, and that those calls are documented, you can create at least two derivative metrics to assess performance: (1) % of accounts called per bucket and (2) collection agents in compliance with the call policy.

Additional metrics to consider are: your invoicing accuracy, billing frequency (as you/others mention above), policy on timing to engage external collection agency, etc.

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There are many things in addition to those already listed.

1. include or exclude intercompany sales, depending on what is desired
2. exclude items in A/R but were unusual items which may not have run through sales, e.g. you may bill for co-op advertising (manufacturer assists a franchisee/dealer with advertising) or other items. What are the things that are included in the numerator but not in the denominator and vice versa
3. exclude sales allowance accruals, the actual amount billed should be used, not "net sales" from the P/L
4. is this a "month end" only calculation or is it practical to calculate more frequently? Depending on your billing and payment due dates the DSO could misrepresent reality if the billing and terms cause payments to always come in the first few days of the month
5. What you are able to do may be restricted by the capabilities of your IT system.
6. Ultimately, in my opinion, don't worry so much about the DSO number and focus on the individual accounts past due and the DSO will take care of itself.

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Proformative Advisor
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1. If you are a public company, then I would make sure your method of DSO calculation aligns with other public companies in your industry. This way analysts can have an apples to apples comparison.
2. If the DSO calculation is for internal reporting only, the key is to pick a method(s) and stick with it over time to be able to spot any trends.

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