A Guide to DSO in SaaS: What days sales outstanding is, why it's important, and how to calculate it

What is Days Sales Outstanding and why is it important for SaaS companies?

A lower DSO implies that the company can convert credit sales into cash relatively quickly, and that receivables remain outstanding (on the balance sheet) for a shorter duration of time. That is, it takes the company less time to collect payments, ensuring a healthy cash flow and better working capital management. 

A higher DSO, on the other hand, implies that the company is unable to quickly convert credit sales into cash and that receivables remain outstanding (on the balance sheet) for a longer duration of time. That is, the company takes longer to collect payments and doesn’t have a healthy cash flow for operations. A higher DSO is typically a poor indicator of a company’s financial health because a higher amount of company’s funds are stuck as working capital. 

While DSO is a widely-used metric in business overall, for SaaS businesses its utility is somewhat limited. This is because in contrast to non-SaaS businesses, DSO is usually less than 30 days. In non-saas businesses, the DSO is usually longer because collections are further away from the sale. For example, a factory that sells widgets to Walmart would likely offer the retail chain payment terms of 30, 60, or 90 days, maybe even 120 days. While the accounts receivable process is clearly important for these kinds of businesses (i.e. those that invoice and receive payment potentially months later), it is less important for SaaS businesses.

This is because SaaS companies typically have shorter payment terms. However, in SaaS, DSO is easier to understand within the context of how those payments are made, which for most SaaS companies happens in one of two ways:   

• Automated payments: This could be business-to-consumer (B2C) SaaS businesses (think Netflix here) or business-to-business (B2B) SaaS companies, such as Salesforce or Quickbooks. For companies that automate payment by billing to a credit card on file, the DSO is effectively zero. This is the same regardless of whether the subscription is monthly or annual because the company invoices and the credit card issues payment almost immediately. 
• Manual payments: While manual payments are non-existent in B2C SaaS, they’re quite common in B2B SaaS. Some B2B SaaS companies do use automated payment systems. However, for those with high annual contract values (ACV) (e.g. thousands of dollars), paying with a credit card just doesn’t make sense. These companies typically have annual or multiyear contracts with terms that require payment within 15-30 days from the date of the invoice. Thus, for SaaS businesses that manually invoice, the DSO is typically 30 days or less.  

In both cases, subscription renewals follow the same process. If payments are automated (barring any issues with the customer’s credit card on file), the plan will automatically renew when the previous subscription ends. 

Likewise, for a company that invoices and collects payments manually, when a customer’s subscription ends, the company issues a new invoice with payment due date based on the terms of the original agreement. 

It is at this point – subscription renewal – that DSO is most useful for SaaS companies. This is where churn happens, and churn can be devastating to a SaaS business. Here’s why: 

• For every single customer that churns, you need to attract two new customers to maintain growth (one new customer to replace the one you lost and another new customer to grow). 
• Churn also has a negative compounding effect, meaning that seemingly incremental changes in churn can have an outsized impact on your revenue over time. 

Suffice it to say, in SaaS, you need to do everything you can to avoid churn. And tracking your DSO might be able to help you do that.  

Here’s the thing…if your company uses an automated payment system, DSO isn’t going to tell you much because your DSO is already zero. In cases where the customer’s credit card is declined, your system may offer some grace period during which the customer receives a reminder or two to fix the situation. But if the payment isn’t made, access to the software is revoked. The churn will have already happened automatically.  

However, if your company invoices manually, looking at DSO both in aggregate and at the individual customer level can give you insights that you can use to be more proactive in preventing churn. This is because manual renewals offer a window of opportunity to intervene if you know that churn is likely, which is something you might be able to see if you’re tracking your DSO.  

If your DSO is increasing. If it is, you’ll want to investigate the issue to determine what’s driving that increase and whether you can do anything to reverse it.  

For example, is the increase in DSO the result of macroeconomic indicators (leading or lagging) that are influencing your customers’ ability to pay on time? If so, you may not be able to do much there. However, if there’s a problem with your invoicing or payment processes, that’s definitely something you can address.  

Perhaps most importantly, you would want to determine if you have a potential problem with customer satisfaction because that could lead to higher churn.

How do you calculate DSO? 

DSO is calculated as the average accounts receivable (AR) for a given period  divided by the total sales (i.e. revenue booked) during the same period, multiplied by the number of days in the period of time. 

You can use any period of time to calculate DSO (monthly, annually, quarterly). The key is to ensure that you’re using the same number of days to calculate the average AR and the revenue booked across the same time period. 

Here’s what the formula might look like for a typical B2B SaaS company that invoices manually on an annual basis:

Calculating DSO on a rolling basis

To gain the most valuable insights DSO has to offer for forecasting your cash flow, you’ll want to track it on a rolling basis.  

Calculating an average DSO, aggregated across all customers, on a 12-month rolling basis  will give you a trend line that will reveal whether it is increasing or decreasing over time. This  gives you a window of opportunity to proactively investigate any increases in your DSO. 

Ultimately, though, the goal of tracking your DSO is to get as granular as possible, ideally down to the customer level. Analyzing DSO at the individual customer level can provide actionable insights into potential issues that can affect the reliability of your cash flow. 

To illustrate this, let’s look at a very simple example where we have a SaaS company with eight customers. Each customer is on an annual contract that requires payment 15 days from the date of invoice. Given this, the company uses an assumed DSO of 15 days in its cash flow forecasting. 

If we were only looking at the rolling DSO in aggregate, this is what we might see for the first month of the quarter:

There is a slight increase in our average DSO, but it’s still lower than our expected DSO of 15 days. So maybe we’re not too worried about that. Then, when we update our DSO with actuals from March, suddenly we find that we may have a bigger problem on our hands.

In order to figure out what’s happening here, we have to drill down to the customer level: 

At the customer level, it’s clear to see that there was actually a problem lurking in that slight increase in February. One of our customers took a lot longer to pay than the others. For Customer 5, the DSO was five days higher than our expected DSO. This may signal that Customer 5 is having trouble paying and may be more likely to churn. In this case, we might  want to have our customer success (CS) team work with Customer 5 to better understand the underlying issue.   

Looking more closely at the increase in March, we are seeing a different story possibly emerging. Our average DSO is clearly increasing faster, and when we look at the individual customer DSOs, we find that they're all paying at the last minute or late. This could represent an increased risk of churn, but it might instead be indicative of larger, macroeconomic conditions that are making it harder in general for customers to pay timely. 

Of course, we can’t fix those kinds of problems. But knowing about them gives us an opportunity to more accurately account for the potential risk to our cash flow in our forecast and proactively adjust our spending if needed. 

Understanding your DSO at the customer level also gives you an opportunity to be proactive in other ways that can help your cash flow. For example, if you do find that there are macroeconomic issues driving your DSO higher, you may want to consider adjusting the payment terms in your contracts to achieve a more predictable cash flow. 

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The key takeaway in this simple example: Understanding DSO at the customer level is necessary to really understand what is driving any increases or decreases in average DSO.   

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The problem is, if you’re using Excel to track your DSO at the customer level, if you have more than around 1,000 customers, it can become very time consuming and unwieldy. One alternative is to group your customers in some way, ideally by similarities in their payment patterns. 

For example, if you have two main types of customers, say SMBs and enterprise, and they have two different types of payment plans. SMBs pay monthly while enterprises pay annually. Thus, that would be a logical way to group your customers to make tracking DSO on a rolling basis easier. 

If you don’t have such clear segments within your customer base, you can experiment with grouping them in other ways, maybe by region or product. When you start grouping customers in different ways and look at their DSOs, you will likely begin to see payment patterns emerge that can help you group them. 

Once you group your customers into different segments, you can calculate an average DSO for each customer group, aggregated across all the customers in that group. This adds a few steps but will make updating your DSO each month a little more manageable when you’re using Excel and have a lot of customers to track.   

What is a good DSO for a SaaS business?

In contrast to other types of businesses that offer extended payment terms, for  SaaS businesses, DSO doesn’t vary much. 

The SaaS business model relies on subscriptions/licenses that grant access to the product to ensure they are paid on time. Given this, customer payment behavior remains fairly consistent. Customers tend to make timely payments to continue to access the product. (And of course, no one wants the hassle of getting their subscriptions or licenses revoked!)

For SaaS companies that invoice manually, DSO should always be less than 15-30, which reflects the typical terms of annual or multiyear SaaS contracts. Of course, companies that use an automated payment system where the customer’s credit card is billed, will have a DSO of zero.   

When a SaaS company that invoices manually has a higher DSO than 30 days, it is not necessarily a cause for alarm. It might mean that the company and the customer care department directed their energies on maintaining the customer relationship — by understanding the issue and showing leniency around payment cycles — instead of simply revoking access.