Using DSO to Measure Receivables; Part 2 – Why Also Calculate Best Possible DSO and Targets?

Best Possible DSO describes the DSO that would be achieved if all customers paid on time, in line with their contractual payment terms. Target DSO, by contrast, describes the level of DSO that management would like to achieve. The DSO value should usually be constant or trending down (unless seasonal volatility is known to push performance out) towards a target DSO (where one has been set) or the BPDSO value. Setting a Target DSO equal to the BPDSO is not realistic though, unless the company has a very limited number of bad paying customers.

The BPDSO calculation should follow the same formula as that chosen to calculate the DSO with only one difference, in the numerator. The total Accounts Receivable balance is replaced by the current due (or not yet due) balance. If BPDSO were to be achieved, it would indicate zero overdue receivables and therefore exceptional performance. However, it may also mean that the terms being offered are too generous. Conversely, if the gap between DSO and BPDSO is growing (even if the DSO is constant), it might be an early sign of deteriorating performance.

Comments on Chart 2: June BPDSO performance indicates an average payment term of 59 days. By September this had reduced to 32 days, suggesting that efforts to tighten terms had been made. Despite this, the gap between BPDSO and DSO in September had widened to 128 days from 99 days in June. This means that September collection performance (in real terms) had slipped by 29 days, not just the 2 days indicated by the DSO (160 versus 158).