Days Sales Outstanding vs. Accounts Receivable Turnover Ratio: What’s the Difference?

Introduction

Days Sales Outstanding (DSO) measures the time it takes for a business to receive payments for credit purchases, impacting cash flow. On the other hand, the Accounts Receivable Turnover Ratio (ART ratio) assesses the efficiency of a company’s collection process, influencing available cash and expected short-term earnings. 

Both these ratios play a pivotal role in assessing a company’s financial health and efficiency in managing its receivables. Here, in this article we’ve broken down the concept and all the important differences between DSO and ART ratio, in tabular form, to make it easier to understand, have a look. 

What Is DSO and How to Calculate It?

Days sales outstanding measures how long it takes for a company to collect its receivables after a credit sale has been made. Many industries use this metric to keep track of their accounts receivables.

The formula for calculating DSO:

Here’s an example with calculation:

If a company ABC makes credit sales worth $50,000 and the account receivables in 20 days are $40,000, then the DSO = ( $40,000/$50,000)*20 = 16. This means that the company takes an average of 16 days to collect its receivables. This can either indicate a low or high DSO considering the company’s payment policy.

A low DSO indicates that the company collects its dues ahead of payment time. A high DSO indicates that the company takes longer to collect its dues than the credit period offered. Ideally, a lower DSO indicates better collection efficiency and a solid credit policy.

Monthly, quarterly and annual assessments of DSO give better insights into the overall performance of your company’s AR team.

What is ART Ratio and How to Calculate It?

The account receivable turnover (ART) ratio measures the number of times a company collects its average accounts receivables within a specific term (monthly, quarterly, or annually). It serves as an indicator of a company’s collections efficiency.

The formula for calculating the ART Ratio is as follows:

Where, Average Accounts Receivable = (Accounts Receivable at the Beginning of the Term + Accounts Receivable at the End of the Term) / 2

Here’s an example with calculation:

If a company ZZZ has net credit sales worth $3,000,000 and an accounts receivable (AR) of $200,000 at the beginning of the year and $225,000 at the end of the year.

• Average AR = ($200,000 + $225,000) / 2 = $212,500
• ART Ratio = $3,000,000 / $212,500 = 14.11

This means that Company ZZZ collects its accounts receivables approximately 14 times a year.

Receivable Turnover in Days:

To find the accounts receivable turnover in days, you can divide 365 by the ART ratio. In the case of Company ZZZ:

Receivable Turnover Ratio in Days (Annual ART) = 365 / 14.11 ≈ 25.86

This indicates that, on average, it takes approximately 26 days for an average customer to repay their debts. If the company has a strict 30-day payment policy, the ART ratio suggests that the company is efficiently collecting its receivables within the payment period, which is a positive sign of a high accounts receivable turnover ratio.

Key Differences Between Days Sales Outstanding and Accounts Receivable Turnover Ratio

The key difference between the Days Sales Outstanding and the Accounts Receivable Turnover Ratio: lies in their focus. DSO measures the average time it takes to collect on receivables, emphasizing collection speed, while the ART ratio assesses how many times receivables are turned over in a specific period, indicating turnover frequency.

The following points provide a detailed explanation of the difference between Days Sales Outstanding and the Accounts Receivable Turnover Ratio:

Why Should You Pay Attention to Both the DSO and ART Ratio?

Here is how the DSO and AR turnover ratio can help you monitor your AR operations.

• Collections efficiency: DSO measures how quickly customers pay, while ART shows invoice payment speed, helping assess collections efficiency.
• Cash-flow forecasting: Low DSO values indicate a healthier cash flow. By forecasting accounts receivable using DSO, you gain insights into your business’s financial health. This information allows you to make informed decisions about investments, allocate resources effectively, and potentially reinvest funds to drive sales growth.
• Customer satisfaction: Monitoring both DSO and ART ratio can provide insights into customer payment behavior. When you notice that your clients are paying before the due date, it indicates they are satisfied with your services. This information can be leveraged to enhance customer relationships by offering discounts and incentives, further solidifying their loyalty.
• Streamlining credit policies: A higher DSO or a lower ART is often an indication that your credit policies are not stringent and that your customers may have received undue credit limits. Thus, tracking DSO and ART helps you know when to adjust your credit policies.

Looking at both DSO and AR turnover ratio metrics collectively is crucial. Often, when analyzed in silos, these metrics can be misleading (e.g. DSO values may vary due to seasonal slumps or spikes in sales).Having another metric to cross-examine the insights helps remove errors in your judgment.

DSO and ART ratio complement each other to give you a more rounded picture of your collection efficiency. They help strengthen credit policies to reduce bad debts. These metrics also help gauge customer experience and satisfaction.

In short, combining these two metrics (DSO and ART ratio) helps you gain a comprehensive understanding of your accounts receivable process, leading to informed and strategic actions.

Wrapping Up

Days Sales Outstanding and Accounts Receivable Turnover Ratio serve as invaluable metrics for gauging your company’s collections efficiency. While each metric offers valuable insights on its own, combining them provides a holistic view of your cash flow and collection processes.

As your business expands, you’ll inevitably face challenges in managing open invoices and evaluating collection success – this is precisely where automation can help. By embracing automation, you can eradicate hours of manual labor and ensure swifter collections, enhancing the overall efficiency of your A/R tasks.

By using AI-driven Accounts Receivable Automation Software, you can significantly expedite cash flow and slash DSO while streamlining your AR operations, making them both more efficient and effective. 

Furthermore, by embracing the eInvoicing and Collections Automation Solution offered by HighRadius, you can take your collections process optimization to the next level.