Do High Accounts Receivable Turnover Ratios Indicate High DSO?
Before implementing new initiatives, you must first understand your company's financial situation. Day Sales Outstanding (DSO) and Accounts Receivable Turnover Ratios (ART) are Key Performance Indicators (KPIs) that provide an overview of your company's current financial performance.
What Is Days Sales Outstanding (DSO)?
Days Sales Outstanding (DSO) is the number of days taking for a company or an organization to recollect or recover the outstanding receivables after credit sales have been made. This technique is used by many organizations to track their Accounts Receivable and this can be calculated by the formula
Days Sales Outstanding = (Accounts Receivables/Total Credit Sales)*No. of Days
Example with XYZ Company:
If an XYZ company makes $850,000 in credit sales and $540,000 in account receivables in 40 days, the DSO = ($850,000/$540,000)*18 = 28. This signifies that the company collects receivables in an average of 28 days. Given the company's payment strategy, this might suggest a low or high DSO.
A lower DSO signifies that the business pays its dues before the credit term, whereas a larger DSO shows that the company collects its rights after the credit period has expired. A higher DSO implies poor collection effectiveness, whereas a lower DSO implies excellent collection efficiency and a sound credit strategy.
What Is the Accounts Receivable Turnover Ratio (ART)?
The Accounts Receivable Turnover Ratio (ART) is the average number of times a company collects Accounts Receivable during a day, week, or month. The higher the A/R is the higher the rate of collection efficiency.
Accounts Receivable Turnover Ratio = Net Credit Sales/Average Accounts Receivables
Example with XYZ Company:
If a company XYZ has $9,000,000 in net credit sales and an AR of $500,000 at the start of the year and $225,000 at the end of the year, then
AR = ($500,000+$225,000)/2 = $362,500
ART = $9,000,000/$362,500 = 24.8
This suggests that the firm XYZ collects receivables 14 times each year.
Divide 365 by the ART ratio to get the account receivable turnover in days.
Reasons to concentrate on DSO and ART
1. Collection Efficiency: The DSO impacts how quickly clients pay and the efficiency of your collections department.
2. Forecasting Cash Flow: Low DSO values suggest a higher cash flow. you can plan investments based on anticipated cash streams or reinvest the funds to increase sales.
3. Customer Satisfaction: if your customers pay before the due date, you can safely assume that they are pleased with your services and wish to continue working with you.
4. Streamlining Credit Policies: A higher DSO or a lower art is frequently an indicator that your credit standards are lax and that your clients have acquired excessive credit limits.
Final Thoughts on Improving Your DSO and ART
There are several strategies for increasing these essential Accounts Receivable metrics since DSO (Days Sales Outstanding) and ART (Accounts Receivable Turnover Ratio) are the two critical performance indicators that establish your company's performance metrics. However, implementing Accounts Receivable Automation Software such as Maxyfi is one of the essential things you can do. Maxyfi is an AI-powered automation software that aids in the quick recovery of your company's accounts receivable and accelerates your cash flow.
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