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Finance Ratio: The DSO Calculation, with Average DSO for the S&P 500

The DSO acronym in finance stands for average days sales outstanding, and is critical to understanding a company’s revenue and sales trends. The DSO calculation is simple, yet its usefulness should not be glossed over.

It’s my hope that by the end of this post you’ll understand how the DSO calculation fits in with a company’s revenue recognition policy, and how that can help a financial analyst spot when a company could be “stuffing the channel”, leading to unsustainable aggressive accounting techniques or even outright fraud.

This lesson will be divided into 4 major sections:

  • Why the DSO calculation is important.
  • How to calculate DSO.
  • How quarterly DSO can detect aggressive accounting (historical example).
  • DSO calculation example from a 10-k, with Average Days Sales Outstanding for the S&P 500.

Why the DSO Calculation is Important

As I alluded to in the beginning of the post, days sales outstanding can assist in finding companies whose sales trends are starting to falter, as the number of days it takes to collect an accounts receivable is a direct signal that customers are either:

  1. Receiving favorable collections terms
  2. Having trouble paying off their vendors

Either of those customer situations don’t bode well for the company to whom receivables are owed, as a continued trend such as these both lead to the same thing, a decrease in future revenue.

When customers receive favorable collections or financing terms, it’s often because the collector (or our company, in this case) does not have much leverage in the process. If the company did, they would not feel the need to extend payment deadlines, as that’s essentially an interest free loan to the account supposed to pay the receivable.

A company could have little leverage because they are desperate for sales, or desperate to make sales near the end of a quarter to hit quotas (and make Wall Street happy).

So, a company could offer attractive collection terms, or even discounts, to incentivize a sale—leading to instant revenue recognition. However, this type of practice isn’t sustainable, and essentially borrows from future revenues (if a customer was going to pay on a regular schedule rather than a rushed schedule at more attractive terms).

The 2nd factor behind a higher DSO calculation possibly indicating trouble with revenues is if a customer is having trouble paying on their obligations.

It should be obvious that a troubled customer doesn’t bode well for the conversion of current revenues to cash, and for the likelihood of continued future revenues from this customer.

Caveat: now, a tough macroeconomic situation such as a global recession or pandemic crisis could naturally skew DSO higher as companies across the board struggle meeting timely obligations on accounts receivable. In this case, a higher DSO is less likely to indicate aggressive accounting and could be instead heavily influenced by outside factors.

How to Calculate DSO

Like I mentioned, the DSO calculation itself is pretty simple.

There are two variations:

  1. A quarterly DSO calculation
  2. An annual DSO calculation

In each case, it’s prudent to compare YOY trends with historical data for this classic finance ratio. Also, comparisons to competitors can also be helpful, but be mindful about comparing things apples-to-apples.

Quarterly DSO (Days Sales Outstanding) = 91.25 * (Accounts Receivable / Quarterly Revenue)

Annual DSO (Days Sales Outstanding) = 365 * (Accounts Receivable / Annual Revenue)

Hopefully the rational behind both formulas are intuitive.

A company, particularly a public corporation dealing with other large enterprises, will tend to have a normal or average number of accounts receivable compared to revenues as a function of its business model. This can vary depending on the business model, but can be compared with itself to identify abnormalities.

According to revenue recognition expert John Del Vecchio, CFA, even a small change in DSO could indicate aggressive revenue recognition, or future revenue problems.

From his classic book he co-authored called What’s Behind the Numbers? : “In John’s experience, even just a few days year-over-year increase in DSO can signal poor earnings quality and potential trouble ahead”.

How Changes in DSO Can Detect Aggressive Accounting (historical example)

Consider Under Armour ($UAA), a classic case of a company whose strong consecutive revenue growth came to a crashing halt, and how much the trends in DSO mirrored the stock (and business’s) performance.

Here’s a screenshot of the company’s ticker over the last 10 years:

The annual trends in DSO can also be sourced quite easily from company financial reports, also displayed here:

Click to zoom

You can see that from 2003 until 2014, DSO found itself in a steady decrease, as revenues grew from $115 million to $3,084 million over the same time period.

But in 2015, DSO increased sharply from 33 days to 40 days, and then from 40 to 47 days, and has stayed around this level ever since—in stark contrast to its former historical average of the mid 30’s during its booming times in the early 2010s.

Since 2015, revenues have continued to increase but at a much slower pace, and the company has not been profitable in 2 of the 4 years from 2016-2019 on a Net Income basis. Operating profits have also sharply declined since 2016 and are mere fractions of the levels achieved in 2015 and 2016 (from the 400s (million $USD) to the 150-200s (million $USD).

Investors who saw the annual increase in DSO from 33 to 40 as reported in the 10-k could’ve sold the stock around $42, before the stock’s colossal crash down to today’s value of $10.

DSO Calculation Example from a 10-k, with Average DSO of the S&P

Now I will take a software company, Citrix Systems ($CTXS), and pull up their latest 10-k to look at their days sales outstanding over the last 4 years.

From Item 6: Selected Financial Data, we can see the total revenue over the last 5 years:

From the Consolidated Balance Sheets, we can find Accounts Receivable:

And from their 10-k filed in 2018, to find Accounts Receivable for 2017 and 2016, also in the Consolidated Balance Sheets:

Taking these data points and inputting them into a simple spreadsheet, we find the DSO calculation for $CTXS as the following:

With the company’s announced transformation from a focus on perpectual licenses to subscriptions, the impact to Days Sales Outstanding and Revenue Recognition moving forward will be something to monitor closely.

Comparing trends with companies who have historically undertook similar transformations, particularly in the software space, could be quite beneficial in understanding this special case.

Average Days Sales Outstanding for the S&P 500

To come up with the DSO calculations for the entire S&P 500, I used the time period for fiscal years 2018/2019, in an attempt to exclude distortions from the latest crisis from the pandemic.

You can see a summary of all 500 companies here:

You’ll notice that some DSO figures are blank, as the API I used to compute these numbers is not perfect. However, excluding the 30-ish companies with no data, I found that the average Days Sales Outstanding (DSO) for the entire S&P 500 was 62 days in the time period examined, with the median DSO at 55 days.