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A KPI that companies can use to measure their financial performance is DSO, the Days Sales Outstanding. With DSO analysis, you find out how efficiently you collect payment for your products or services. The lower the DSO figure, the better the cash flow.
Calculating your DSO is one thing, but interpreting the figure is another. Therefore, compare and benchmark your DSO to get new insights.
In this article:
- We show that DSO is different for every industry and sector
- You will find out how payment terms and payment options affect your DSO
- You will find out that DSO is also dependent on external factors, over which you have little influence
What is DSO?
Let’s refresh ourselves on how to calculate DSO. The simplest and most frequently used method is to divide the month-end receivable balance by the month-end turnover and multiply the result by 30.
(End of Month Account Balance / Monthly Revenue) x 30 = DSO
Of course, you can make the calculation for periods other than a month (30 days).
What is a good DSO?
Calculating and determining your DSO is one thing, but interpreting the figure is another. There is no such thing as an ideal DSO that will say you are doing well as a company, because there are just too many factors that have an impact on the DSO and determine what a good or bad one is.
Various factors affect the DSO.
How should you compare or benchmark your DSO?
The average DSO in your sector can serve as a benchmark against which you can measure your company’s performance. But there can also be differences between companies.
Here are a few ideas for how you should compare and benchmark your DSO.
DSO varies enormously by industry. A good DSO in one industry may mean a poor performance in another.
Companies with large capital expenditures, such as manufacturing companies, typically have a different DSO to that of companies providing daily products and services, such as food.
According to a global study covering 21 sectors by Euler Hermes, the sectors with the highest DSOs in 2020 were Mechanical Engineering (92 days), Construction (82 days) and Electronics (77 days). The lowest DSOs were found in Retail (26 days), Food (43 days) and Transport (47 days). The DSO for each sector also varies greatly from country to country.
Here is the global DSO in 2020, from lowest to highest by sector:
|Oil & gas||58|
|Personal items & recreation||58|
Source: Euler Hermes
Comparing your DSO with similar companies in the same sector is certainly an interesting exercise. But bear in mind that the DSOs of companies within the same sector can also vary significantly. This is often related to the business model used and numerous business parameters.
The DSO is relatively easy to find for listed companies. You can look it up on financial sites or in the annual and quarterly reports of the companies themselves. Try to use the median DSO instead of the average DSO whenever possible.
Here are some examples:
|Company||Current DSO||10 year historic DSO (median)||Industry||Industry median DSO|
|Johnson & Johnson||58||59||Pharmaceuticals||70|
|Exxon Mobil||37||26||Oil & Gas||48|
Source: Gurufocus (data from Aug-Sep-Oct-Nov 21)
What is the payment term for your company? Should invoices be paid within 30 days, or rather 60 or 90 days? The payment term employed has a major effect on the final DSO.
Company A is used to working with a ten-day payment term, when suddenly a very large customer comes forward and only pays after 30 days. The DSO increases from 10 to, say, 20.
Company B applies a 20-day payment term, from which it never deviates. The DSO always remains stable at or around 20. Company B is used to taking this payment term into account. Company A, on the other hand, has to be more cautious because DSO has increased.
You should also consider how the payment term offered affects the payment behaviour of your customers. If the DSO is higher than the payment term, it might be time to evaluate your collection process or debtor management.
Other factors that can influence the payment term are increasing competition (the payment term must become more flexible), large customers exerting pressure to pay later or larger projects (with large part payments depending on milestones achieved).
If you want to improve your customers’ payment behaviour, offering different payment options is a must. After all, the faster customers pay, the better your DSO.
Therefore, always provide a payment link or a QR code on your physical letters in your invoices and reminders, and do not forget to offer payment options when you send text or WhatsApp messages.
DSO is not a fixed number and may fluctuate from month to month, or from season to season. This is because companies’ turnover can vary greatly from month to month. If one large order is received in the spring, this can distort the DSO a few months later.
Example: In a period that follows a peak period, company A sends out a lot fewer invoices. If some of these invoices are then paid late, the DSO goes up for that period.
If you take the 12-month average of the DSO, you will not take into account the months in which there are more, or fewer, sales. These can lower or raise the DSO.
Therefore, as a benchmark for the DSO, it is better to use the DSO for the same period last year. That will give you a more precise insight.
According to the same Euler Hermes study of some 40,000 companies worldwide, the global DSO in 2020 was 66 days, compared with 64 days in 2019.
But there are big differences from one country or region to another. The three countries with the highest DSOs in 2020 were China (94 days), Italy (88 days) and Greece (84 days). The countries with the lowest DSOs in 2020 were New Zealand (40 days), the Netherlands (45 days) and Finland (46 days).
Different countries have different payment cultures. In some countries, it is part of the business culture to pay faster, and the DSO is relatively low; in other countries, people take longer to pay.
Your customers’ payment behaviour depends not only on internal decisions but also on external factors. And of course you have less control over that.
Cycles of economic growth and recessions alternate. When the economy or certain sectors falter, this may have an impact on the financial possibilities for some companies.
- Pandemic or public health crisis
The arrival of the coronavirus and Covid-19 was totally unexpected and had a major impact on the world economy.
- Geopolitical events
Trade wars (e.g. China and the USA), falling currencies (e.g. the Turkish Lira) and price wars (e.g. oil) can occur quite suddenly. This represents a considerable challenge for companies operating in these regions or sectors.
- New technology
The arrival of new technologies – and often new competitors – can quickly turn an entire industry on its head.
The best way to protect yourself from all these changes and influences is to review your DSO regularly and adjust it where possible. Automatic debtor management and, by extension, credit management, are indispensable in this regard. When unexpected events occur, your DSO is better prepared.