How is days in accounts receivable (DSO) calculated, and what does a lower DSO indicate?

• A. DSO = (Average AR balance / Average daily charges) x 365; lower DSO indicates slower payments.
• B. DSO = (Average AR balance / Average daily charges) x 30; lower DSO indicates faster payments.
• C. DSO = (Average AR balance / Average daily charges) x days; lower DSO indicates faster payments and better cash flow.
• D. DSO = (Average AR balance / Average daily charges) x 7; lower DSO indicates higher cash reserves.

Answer: (C)

DSO measures how long, on average, it takes to collect cash after a sale. It links the money tied up in receivables (average AR) to the daily rate at which the business is turning sales into cash (average daily charges or daily sales). To express DSO in days for a given period, you compare average AR to average daily sales and then multiply by the number of days in that period. In practice this means using the ratio of average AR to average daily sales, with the period length used to scale if you’re not using an annual figure.

A lower DSO means customers are paying more quickly, which frees up cash sooner and improves liquidity and overall cash flow. If collections slow down, DSO rises, tying up more working capital and stressing cash flow.