Financial Analysis

Understanding Accounts Receivable Metrics: DSO, CPI, CEI

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Day’s sales outstanding (DSO) is a commonly used metric to compare a company’s accounts receivable to prior periods and to industry norms. A company’s DSO is the average number of days it takes to collect cash from credit sales.

Finance professionals calculate DSO by dividing Total Accounts Receivable (A/R) by Total Credit Sales multiplied by the number of days in the measurement period.

A low DSO means that it takes a company fewer days to collect credit sales. A high DSO shows that a company is selling its product or services to customers on credit and taking longer to collect related payments.

Because DSO just looks at credit sales, it is not a good overall indicator for the performance of companies that have significant cash sales, which for accounting purposes include credit card sales.

Typically, DSO is considered to be within reasonable limits if it exceeds terms by no more than one-third to one-half.   So if terms are 30 days, an acceptable DSO might be between 40 and 45 days. Significant changes in DSO from period to period should be examined carefully.

If the sales are of seasonal nature and payment terms reflect the products sold, calculate different period DSO (monthly basis DSO, quarterly basis DSO and annual basis DSO). Every month calculate the weighted average payment term on all unpaid invoices (in order to evaluate the performance with the 1 month and quarterly DSO). If payment term varies a correlation with the past due accounts receivable to ensure DSO information demonstrates the accurate situation of the receivables.
 

For companies using Collection Productivity Index (CPI), it is the amount of cash collected per collector as a % of the opening A/R for each fiscal quarter. As quarterly sales are not linear month to month, (heavily weighted in a particular month) you will find this to be a valuable measure not only at the collector level but regionally and globally, for quarterly and annual performance measures and cash flow forecasting based on trends. Seasonal changes in quarters that can align with a fairly high level of accuracy against this metric.

 

Collection Effectiveness Index (CEI) can be used because it is a "No Balance Sheet" calculation. It is also useful (far more so than the DSO) in forecasting cash receipts from month to month, and because you do not use amounts not yet due in the "collectable" portion of the equation, it avoids the possible skewing effect of extended terms, or dating

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