Accountants use two key metrics when measuring a company’s liquidity: receivables turnover and days sales outstanding. But what are the main differences between these two metrics? Why do they matter? And which one is better? Take a look at the key differences between average days to pay vs dso and why each metric matters for businesses.
What Is Receivables Turnover?
Also known as accounts receivable turnover, it measures the average number of times that a company’s receivables are turned over or collected. This metric is important because it shows how well a company manages its receivables. A high receivables turnover ratio indicates that a company collects its receivables quickly.
How To Calculate Accounts Receivable Turnover
To calculate receivables turnover, divide the net credit sales by the average AR. You can find the average AR by adding the beginning and ending AR values together for that period and dividing them by 2.
For example, let’s say that a company has $100,000 in net credit sales and an average AR of $50,000. The receivables turnover ratio would be:
Receivables Turnover = Net Credit Sales/Average Accounts Receivable
Receivables Turnover = $100,000/$50,000
Receivables Turnover = 2
Pros of Calculating the Accounts Receivable Turnover Ratio
Is it worth calculating the accounts receivable turnover if you already calculate the DSO? Consider the following benefits:
- It’s a relatively easy metric to calculate. You need a company’s total sales and average accounts receivable for a period.
- It provides valuable insights into a company’s ability to collect its receivables.
- Analysts can use it to compare companies within the same industry.
Cons of Calculating the Accounts Receivable Turnover Ratio
No KPI is perfect. This is why it’s so important to use more than one when measuring cash flow and liquidity. Consider these drawbacks:
- The receivables turnover ratio only measures how quickly a company collects its receivables. It doesn’t say anything about the quality of those receivables.
- Several factors can affect the ratio, such as changes in credit terms or the mix of products sold.
What Is the Days Sales Outstanding Ratio?
Also known as days sales in average receivables, this metric measures the average number of days that it takes for a company to collect payment on its sales. This metric is important because it shows how long it takes for a company to get paid for its products or services. A high DSO indicates that it takes longer for a company to get paid, which can mean financial trouble.
How To Calculate DSO
To calculate DSO, you need to divide a company’s average accounts receivable by its sales per day.
DSO = (average accounts receivable/total sales per day) x days
For example, let’s say that a company has $100,000 in average accounts receivable and $500,000 in total sales per day. The company’s DSO would be:
DSO = ($100,000/$500,000) x 365 days
DSO = 73 days
Pros of Calculating the DSO
Most companies treat days sales outstanding in accounts receivable as one of the most important. That’s because it brings these and so many other benefits to the table:
- It makes it easier for companies to quantify the ability to calculate debts.
- Managers can use days receivable outstanding information to make better decisions that affect cash flow.
- DSO adds a level of predictability to cash flow, making it easier to adjust the collections process and improve profitability.
Cons of Calculating the DSO
Despite the popularity and benefits of the days sale outstanding ratio, it has the same drawbacks as the accounts receivable turnover calculations.
Receivables Turnover Vs. Days Sales Outstanding: Which One Is Better?
The main difference between receivables turnover and days sales outstanding is that receivables turnover measures how quickly a company collects its receivables. In contrast, DSO measures how long it takes for a company to get paid for its products or services. So, which one is the better metric to use when calculating a company’s liquidity? The answer is that it depends on your specific needs and goals.
If you’re looking for a quick and easy way to measure a company’s ability to collect its receivables, then receivables turnover is the way to go. But if you’re looking for a more comprehensive metric that considers the quality of receivables, then calculating DSO or days sales in receivables is the better choice.
No matter which metric you choose, it’s essential to use multiple cash flow and liquidity measures when making business decisions. By using both receivables turnover and days sales outstanding, you can get a complete picture of a company’s financial health.
How Can You Simplify the Process of Calculating ART and DSO?
Manually calculating these and other KPIs might seem like a good idea on paper. However, over time, they can introduce inefficiencies and inaccuracies. Remember that decisions are only as good as the data used to inform them, so it’s a better idea to automate this process.
An automated solution can quickly and accurately calculate receivables turnover, days sales outstanding, and other cash flow metrics. Automation software can also regularly complete this task or provide real-time information that changes with each new data entry.
Some companies use spreadsheets to automate the process. However, this is not true automation and can generate about as many errors as doing it manually. This can compound the error when formulas get copied from cell to cell. Each succeeding calculation using that original data will then generate inaccurate data.
What Is a Good or Bad Collections Rate?
A few important factors determine whether you have a reasonable collections rate. The most crucial factor is the terms of your agreement. For example, if you offer credit that customers should repay in 30 days and your DSO is 73, you are way behind your collections goals. Here are some additional factors:
- The industry your business operates in and the norm for that industry
- The region your business operates in and the norm for that geographical area
- Economic changes and how current performance compares with prior periods
- The collections goals set by the financial controller or CPO
Timely and accurate information is crucial when calculating average days to pay vs DSO. Leverage automation to simplify this task for your business.
