Display of Receivables definition in purple highlighter

 

How to Compute Days Sales Receivables or More Commonly “DSR” and Improve Cash Flow


Why is Knowing How to Compute Days Sales Receivables Important to my Business?

Days Sales Receivables (DSR) is an efficiency metric for determining how quickly a business is able to convert a receivable into cash.  Sometimes it is referred to as Days Sales Outstanding or DSO.  In either case, it is the same business metric.

Since cash is king, the faster a business is able to convert a receivable into cash, the better.  Essentially, a receivable is created when a business extends credit to a customer.  Some businesses do not need to extend credit at all, and consequently have $0 receivables.  For example, McDonalds does not extend credit when you purchase a cheese burger.  You give them the cash and you get your cheese burger.  If you were to look at McDonalds SEC filings and review the level of receivables on their publicly listed balance sheet, you would see a very small number given their revenue size. 

Learn how to compute days sales receivables, or commonly know as DSR, and learn ways to utilize this valuable metric to improve cash flow. Click to Tweet

Most businesses have to extend credit to their customers.  For example, if you sell products to retail stores as a wholesaler, then you are going to have to extend credit to your customers.  If you were able to negotiate 30-day terms with all your customers and they precisely paid in 30 days, then your DSR would be 30 days.  In reality, no business collects in precisely the number of days they negotiate with their customers and generally the resulting DSR is worse than what is negotiated for various reasons.  But you want to pay particularly close attention to your business’ overall DSR performance to ensure it does not drift upward, or if does drift upward you understand the circumstances and have someone “bird dogging” customers for payment as well as enforcing credit holds when merited.  As a CFO Services firm to midsize businesses, we frequently see business owners ignoring their overall DSR trends until they have a significant liquidity problem that could have been prevented by more diligently monitoring their metrics. 

How to Compute “Days Sales Receivables”

DSR like most financial metrics is retrospective in that you have to use historical business activity to compute the current month metric.  There are basically two methods: 1) the look back method; and 2) the rolling 12-month method.  I made up the name of the second method, because I am not sure if it has an actual name, but it is the more commonly used.  This is because it is much easier to implement the rolling 12-month method in a spread sheet vs. the look back method.  We will start with the look back method.    

Computing DSR Using the Look Back Method

In either methodology, you start with the month-ending accounts receivable balance for a business.  Though both methods given fairly similar results, the look back method is more well suited for monitoring DSR at a more granular level.  For example, you would probably want to use the look back method if you were a construction firm and needed to understand DSR at a customer level.  In summary, you start with the month-end receivable balance and you begin subtracting the monthly sales from the outstanding receivables balance, adding the calendar days from each month, until you go back far enough to bring the balance to $0.  Typically you end up having to prorate the final month.

DSR calculation example using look back method

The example above reflects a single customer (Customer XYZ), with a month-end October receivable balance totaling $450K.  On the next row you can see the monthly invoicing to this customer.  To compute the DSR, we work backwards beginning with October 2021, by subtracting the monthly invoicing from the month-end October receivable balance, accumulating the days in each month.  Starting in October, with a $450K balance, we subtract the October 2021 invoicing (invoicing equates to monthly sales) and get a balance of $375K.  We then subtract the $375K balance from the $43K September invoicing to get $332K.  This goes on until we get to $0K remaining receivables which happens in March.

The invoicing in March is greater than the $73K remaining balance from April; consequently we do not add the full 31 calendars for March, but prorate the 31 days.  The March days are prorated by dividing the remaining balance ($73K) by the total March invoicing ($80K) and multiplying that fraction by the number of calendar days in March (31) or $73K Remaining / $80K Total Mar Invoicing * 31 Days = 28 Prorate Days for March.  Then we add the days for March through October and get 242 Days Sales Receivable.  This is huge DSR and indicates that the business have 242 days worth of invoicing extended as credit to this customer or about (242 Days / 30 Days Per Month) 8 months of work. 

As you can surmise, using the look back method is a little complicated.  But it does provide accurate DSR metrics when looking at an individual customer or in situations where invoicing/revenue is lumpy throughout the year.  To easily implement the look back methodology, you will need a custom function macro.  Contact us if you would like a copy of the function macro to perform this calculation.  If your revenue tends to be relatively consistent, then you want to use the rolling 12-month methodology.

Computing DSR Using the Rolling 12-Month Method

As mentioned earlier, the rolling 12-month method is much easier to implement in a spreadsheet application.  The method works well for businesses that have fairly stable revenue, with multiple customers.  Here is an example of the rolling 12-month method:

Example of computing DSR using the 12-month rolling methodology.

In this example, we have hidden the April through August columns for brevity.  Here we are computing the DSR for ME December 2021.  Since this is a 12-month rolling method, we accumulate the prior 12 months of sales, which was $12,685K.  Then we need to compute the average daily sales, which is $12,685K / 365 Days = $34.75K per day.  Now that we know what the average per day sales equates to, we just need to divide the month-end December receivables balance by this factor to determine that we have 46 days of receivables currently (or $1,585K / ($12,685K / 365 Days) = 46 DSR). 

The following month, we would divide the January 2022 month-end receivable balance by the 12-month average daily sales, which would include sales for February 2021 through January 2022, and so on and so forth.

Gaining Actionable Intelligence Regarding DSR

The first step is gaining actionable intelligence is to put together a time phased financial plan that includes a forecast for both revenue and receivables.  The starting point for this exercise would start with computing the DSR trends for the previous year to gain a good understanding of collection effectiveness.  Using the prior year trend as a baseline, you can develop a generalized plan as to the DSR target.  With the DSR target in hand as well as the revenue projection, you can back into the receivables plan. 

Graphical Trend of DSR for 2020

This is a good template for tracking receivables.  You can see that on the left Y axis we are measuring monthly dollars of receivables.  On the right Y axis we are measuring the DSR.  The 2018 and 2019 year-end total receivables and DSR values are posted for reference.  The 2018 ending DSR was 52 (see the yellow dot with the 52 below it) and 2019 ending was 51 days.  The total receivables dollars increased from 2018 to 2019, from $1.5M (see the bottom of the column) in 2018 to $1.9M in 2019, while the net DSR decreased a day.  This occurred because 2019 sales were 20% higher than in 2018.  This is a good example where you cannot just look at the total receivables to figure out how efficiently you are collecting receivables. 

You can also see that sales have been strong in 1Q 2020 and collections through February have deteriorated to 63 days of receivables on the balance sheet.  Now is a good time to take a deeper dive into collections to better understand what is driving this increase to make sure there are no major issues.  Using a tool similar to the above display helps business owners know when to dig into the detail and when to just tweak business processes, such as the number of days of credit extended to new customers, to affect cash flow.

Benchmarking and It’s Relevance to Managing DSR

Benchmarking is essentially the process of comparing a company’s financial metrics against an industry cohort of similar size.  There are a number of places to get industry cohort metrics, one of which is the Almanac of Business and Industrial Financial Ratios, written by Leo Troy, Ph.D. and published by CCH. 

We have posted a copy of the page that relates to the this business below.  The columns relate to the asset level with the industry group.  For our company referenced above, the Receivables Turnover metric was 14.9x.  To convert the Turnover to DSR we have to divide the number of days by the Turnover 365 Days / 14.9x = 24 Days.  Given that our business DSR is in the low 50 days, this would indicate that other businesses within this industry are doing much better.

Benchmark Almanac

The 24 Day DSR more than likely requires more research.  The cohort businesses may have a greater level of cash sales than our example company.  But if our example company were able to achieve a DSR at 24 days, the Receivables would be cut in half increasing cash flow about $1.2M.  Benchmarking is helpful, but the key is continuous improvement.  The business ended 2019 at 51 days, which is better than 2018.  With resources, the business should attempt to bring the DSR closer to 45 days by implementing strategies with key customers.

Final Comments on Days Sales Receivables

Managing receivables effectively is a management imperative for all businesses that extend credit.  Your ability to management this important asset will be the difference between a business owner being a prince or a pauper.  Learn the basics.  Set up metrics so that you can monitor monthly changes in efficiency, such as the graph displayed above, and ask probing questions when trends are going in the wrong direction.  At least quarterly, go through the sub-ledger details with your accounting staff and identify actions for improving collections and write offs.  If you need a copy of the look back method Excel function macro, please contact us.

 

About the Author
About the Author
Chase Morrison  provides CFO services, utilizing Profitwyse’s 3D Growth Platform™, enabling his business owner clients to more readily achieve their goals for wealth creation and family legacy.  Contact him today to learn how your business can hit the accelerator using Profitwyse’s proven platform.

 

 

Six Eye-Opening Questions To Ask Your Controller


Whether you have a financial controller or not, someone in your company has the role of top dog accounting person.  As CFO consultants, we seek out that top dog accountant to gain insight into the state of the state when engaging new clients.  We have found that these six eye-opening questions to ask your controller have proven to be prescient when identifying how and where to focus our consulting efforts.  The six questions along with a brief explanation as to each question’s relevance, are as follows:

Utilize our six eye-opening questions to ask your controller to learn more about the status of your organization's financial management capability. Click to Tweet

Question #1 Can I review your accounting close task list?

There should be a list of monthly close entries and quarterly accounting reviews for balance sheet accounts and other reconciliations.  Having a task list illustrates an understanding of the interdependencies that exist in the close process as well as the underlying sense of urgency, which exhibits a good level of discipline.  Not having a list should be a concern, because it reduces trust in both the accuracy and timeliness of financials. You can learn more in our earlier post on what the reasons are for effectively closing your accounting books.

Question #2 What are your top three business concerns and/or frustrations?

CEOs and business owners, from time to time, should consult with their controllers about the concerns and frustrations affecting the accounting function.  Controllers experience the end result of nearly every business process; consequently, they have a unique perspective on what processes are working well and more importantly, not working well.  Do not ignore this valuable source of feedback.  You might be surprised what you learn…

Question #3 Where Are We Least Efficiently Using Our Resources?

This allows your controller to articulate where they see others within the organization using scarce resources less effectively.  Perhaps there are employees in Sales submitting excessive travel expenses or the company is not leveraging its ability to negotiate competitive pricing for inventory.  Whatever it may be, controllers do have a good sense where value is being created and destroyed within an organization.

Question #4 How Frequently Do We Have To Reissue a Payroll Check or an A/P Check and/or Correct An Invoice?

These nonvalue-add activities sap resources and reflect poorly on business processes used throughout the organization.  Excessive errors, such as these, can be indicative of larger business issues that need to be addressed.  Start tracking these errors and stamp out the root causes with a vengenance.

Question #5 Can You Describe How The Dimensional Data That Is Used to Record Accounting Transactions Supports Our Business Strategy?

Not having a strategy is not the controller’s fault, but if you have a strategy then the accounting system should generate metrics to support it.  Regardless as to whether you are using SAP or QuickBooks, there are many ways to code transactions and produce metrics that are aligned with strategy.  The sales can pertain to sales initiatives, quality control metrics and operational effectiveness.  If you are not doing so already, figure out how to use your accounting system more fully to instill greater accountability throughout your organization. 

To learn more about how dimensional data works, see our earlier post on considerations when setting up or modifying your accounting/ERP system.

Question #6 How Are You Monitoring Our DSO, DIOH and DPO Trends, And What Are Those Metrics Telling You About Our Cash Management?

Cash is king and how your business performs on these three metrics will make you a prince or a pauper.  The metrics are Days Sales Outstanding, Days Inventory On Hand and Days Payable Outstanding.  The net of the three equals your cash cycle.  If your controller is not already tracking these metrics, then that person needs to immediately learn how.

We establish financial management dashboards for all of our clients that include all three when appropriate.  Clients with no inventory do not need a DIOH metric.

Profitwyse provides the expertise needed to overcome these issues and will transform your accounting function into a value adding asset.  Contact us today to learn more about our 3D Financial Analysis process to get your business on the right track.  

 

About the Author
About the Author
Chase Morrison provides CFO services, utilizing Profitwyse’s 3D Growth Platform™, enabling his business owner clients to more readily achieve their goals for wealth creation and family legacy.  Contact him today to learn how your business can hit the accelerator using Profitwyse’s proven platform.

 

 

“Lies, Damned Lies, and Statistics” — WTF?


I guess you could say the perceived use and value of statistics has changed a bit since Mark Twain popularized this phrase in the early 1900’s.  Today, there’s no disputing the power and value of statistics in business, though it is woefully underutilized by small and midsize businesses.  The redemption of statistics from Mr. Twain’s satirical antipathy began in earnest during WWII.  Here is one of those stories that Americans can be thankful for.

Statistics in the Trenches

Around 1933, the brilliant statistician Abraham Wald immigrated to the US and was recruited to help with the US war effort by the Statistical Research Group.  Early on, the group was presented with photos of returning battle-tested planes riddled with bullet holes and asked to find a design solution for armoring future planes.  Most holes were in fuselages, wings and tails with few in engines.  The military wanted more armor in the areas with the most bullet holes and asked how to better protect planes.  Wald famously gave a counter-intuitive answer to their query.  He explained that you don’t want to put armor where the bullet holes are.  The armor needs to go where the bullet holes aren’t, which was on the engines.  Wald insight, which today is called survivor bias, save many lives by focusing on why planes were not returning, which was due to bullet holes in engines.

Though Mark Twain may have disparaged statistics back in the day, your business' success most likely depends analytics to thrive! Click to Tweet

What Does This Have to do With Business?

There are many lessons in this story.  One is that there is frequently more value in dissecting failure than success.  When analyzing business failures, such as customer losses or employee departures, take a “lessons learned” approach and then implement remedial solutions.  Another is the importance of statistics to continuous improvement.  Like in war, in business small improvements have out-sized effects.

Customer Satisfaction and Statistics are Highly Correlated

An example in business relates to product service levels and reorder points.  A service level for a given product is the probability that it is available when ordered.  A 95% service level also implies a 5% chance of stockout.  Applying statistics to historical demand and lead time, one can compute a reorder point that ensures a 95% service level.  Utilizing this statistical technique with clients, we bring greater confidence to their replenishment efforts and greater control to inventory levels, helping them make better decisions that drive profitability and cash flow.  No lie!  Contact us today to learn more.

If you are a business owner that is looking for ways to leverage your data analytics, please contact us today

 

About the Author
About the Author
Chase Morrison  provides CFO services, utilizing Profitwyse’s 3D Growth Platform™, enabling his business owner clients to more readily achieve their goals for wealth creation and family legacy.  Contact him today to learn how your business can hit the accelerator using Profitwyse’s proven platform.