Account Receivable days indicate how many days it takes to collect the money from customers.
Days Sales Outstanding = 365 / Account Receivable turnover ratio
If the Account Receivable Turnover ratio is 10, then the account receivable days is 36.5 days.
It takes 36.5 days to collect the money from the customer.
How to use Practically
A high DSO value indicates a company is experiencing a difficult time when converting credit sales to cash.
A low DSO may indicate two things, first – the company is able to convert the credit sales into money/cash very quickly, and second – the quality of the customer with which the companies deal is also very high quality because if the customer is of not high quality means, the customer will be not able to give the money to the company in the right time.
Normally DSO of 30 days is considered good for the company. Especially large-cap companies can have even higher DSO days because they deal with a wide variety of customers all over the world.
But small-cap companies should have lesser DSO or else there will be a liquidity crunch in their working capital management. If the small companies are not able to convert the credit sales into profit very quickly they may sooner or later face serious financial troubles.
A low DSO is more favorable to a company’s collection process which means customers are paying very quickly to get some discounts from the company or the company has a very strict on its credit policy.
Having a very strict credit policy may not always work because the customer may not be interested in dealing will the company and sales growth may get impacted.
So the investor must look for companies with low DSO and high revenue growth. By following this way, investors may be able to identify good companies.