What is Best Possible DSO?

Best Possible DSO Definition

Best possible DSO (Days Sales Outstanding) is a measure that tells you the shortest realistic time frame in which you can expect to collect payments from customers after making a credit sale. 

It's like looking at the best-case scenario for how quickly you can turn gross sales into cash in your bank account.

How BPDSO Works

• Calculate Average Sales Per Day: First, figure out how much you sell on average each day. You do this by dividing your total sales over a certain period by days.
• Identify Current Receivables: Look at the money customers currently owe you. These are your accounts receivable.
• Consider Total Credit Sales: Since DSO focuses on credit sales (where you didn’t get paid immediately), ensure your calculation only includes these, not cash sales.

Note: Trade credit insurance protects businesses against non-payment risk. It allows them to achieve the best possible days sales outstanding by ensuring that receivables get collected promptly and financial stability is maintained. 

Best Possible DSO Formula

Best Possible DSO = (Current Receivables − Past Due Receivables / Total Credit Sales) × Number of Days

• Current Receivables: The total money due from credit sales at the end of the period.
• Past Due Receivables: Receivable balance that is overdue, which you subtract from the current receivables to focus on the best-case scenario.
• Total Credit Sales: The total sales made on credit during the period.
• Number of Days: The total days in the period you're analyzing.

Best Possible DSO Calculation

Let's review a best DSO example to see how quickly a company can realistically expect to collect payments from credit sales.

Imagine that, over a month, Company ABC made $30,000 in credit sales. At the end of the month, their total receivables are $10,000, but $2,000 is past due, meaning it's money that should have already been paid according to payment terms. 

Best possible DSO calculation:

• Average Daily Sales: Divide monthly credit sales by the days in the month. Assuming it's February with 28 days, the average daily sales will be $30,000/28 = $1,071.43.
• Current Receivables Not Past Due: Since $2,000 is past due, the current receivables that are not past due amount to $10,000−$2,000 = $8,000.
• BPDSO Calculation: Divide the current receivables not past due by your total credit sales, then multiply by the days in the period to find the BPDSO. 

BPDSO = ($8,000 / $30,000) × 28

Company A's best possible DSO in this example is approximately 7.47 days. Under the best-case scenario, the company is realistically collecting payments on credit sales in just over seven days, which is excellent for maintaining a healthy cash flow.

Good Best Possible DSO and Bad Best Possible DSO

A lower BPDSO suggests efficient credit and collections practices, meaning you're selling well and collecting payments swiftly. A good DSO is close to your payment terms. For example, if your standard payment terms are 30 days and your BPDSO is near this range or lower, you're collecting payments effectively.

A bad DSO is significantly higher than your standard payment terms, indicating delays in collecting payments. A high DSO suggests that, even in the best-case scenario, you're waiting longer to get paid, which can cause a cash flow problem. This could be due to various factors, such as lenient credit policies, ineffective collections processes, or customers consistently paying late. For instance, if your payment terms are 30 days but your BPDSO is 45 days or more, there's room for improvement in receivables and collections.

Best Possible DSO vs. Standard DSO

The best possible DSO is an ideal scenario. It shows you the shortest realistic time frame in which you could collect all your outstanding payments, assuming everything goes perfectly. 

This metric helps you gauge your collections process efficiency. A lower Best Possible DSO indicates that you can collect payments quickly, which is great for your cash flow. Consider this example: for professional services companies, getting the best possible DSO is vital for providing uninterrupted services to customers. 

Understanding DSO (Day Sales Outstanding) gives you a broader picture. It measures the time it takes to collect customer payments. Unlike Best Possible DSO, Standard DSO includes all outstanding receivables. This metric reflects your collection practices and provides information on late payments. 

A high days sale outstanding can signal issues with your collections process or indicate that customers are taking longer to pay. This could tie up your cash and affect your ability to manage and grow your business. A lower DSO is an excellent place to be.

DSO Ratio Formula

To calculate your average DSO (Days Sales Outstanding), follow these steps:

• Total Your Accounts Receivable: Add up all the money owed to you from sales on credit.
• Calculate Your Total Credit Sales: Figure out the total sales you made on credit during that same period.
• Find Your Daily Sales Average: Divide your total credit sales by the time in the period to get your average daily sales. You can calculate DSO using the formula below.

Days Sales Outstanding Formula:

DSO Value = (Total Accounts Receivable / Total Credit Sale) × Days in the Period)

This DSO calculator shows the average days to collect payments after a sale, giving insight into your cash flow efficiency. A low DSO indicates that you generally collect your receivables on time. 

Note: A different concept, days payable outstanding (DPO), measures the average time a company takes to clear its accounts payable.

Best Practices for Best Possible DSO

Follow these best practices in reducing DSO to ensure you collect payments as efficiently as possible:

• Payment Terms: From the start, make sure your payment terms are clear and agreed upon by both parties. This sets expectations for when payments should be made.
• Invoice Promptly: Send invoices as soon as a sale is completed. Ensure all invoices are accurate to avoid delays caused by discrepancies that need to be resolved.
• Offer Payment Options: Offer various payment methods to make it easy for your customers to pay. 
• Communicate Regularly: Stay in touch with your customers, especially as payment due dates approach. Friendly reminders can keep your invoice at the top of their minds.
• Monitor Your Accounts Receivable: Monitor your accounts receivable aging report. This will help you quickly identify and address overdue invoices.
• Enforce Your Payment Terms: Be firm about your payment terms. Apply late fees and follow up on overdue payments. 
• Build Strong Relationships: Maintain good relationships with your customers. A customer who values your relationship is more likely to pay on time.
• Use Technology: Leverage accounting software or an accounts receivable software to streamline your billing process. Automation can reduce errors and save time.
• Evaluate Customer Creditworthiness: Evaluate a customer's ability to pay before extending credit. This involves credit management or financial assessments and determining overall creditworthiness.
• Offer Early Payment Discounts: Incentivize customers to pay early by offering discounts. Even a tiny discount can motivate quicker payment.

FAQs

1) What does best possible DSO mean?

Best possible DSO is the shortest time a company takes to collect customer payments after making a sale, aiming for efficient cash flow.

2) What is the best DSO ratio?

The best DSO ratio varies by industry, but a lower DSO, close to the company's payment terms, indicates efficient collection and strong cash flow management.

3) What is considered a high DSO? 

A high DSO is when a company takes significantly longer than its standard payment terms to collect customer payments, indicating potential cash flow issues.

4) What is the average DSO by industry? 

The average DSO varies widely by industry; for example, manufacturing can have a DSO of 40-50 days, while retail could be lower at 20-30 days, reflecting different credit and collection practices.