Days Sales Outstanding (DSO)

The situation described in the article can be understood clearly through Days Sales Outstanding (DSO), an important working-capital and cash-flow indicator.

1. What is DSO?

Days Sales Outstanding (DSO) measures the average number of days a company takes to collect cash after making a credit sale.

A common formula is:

$$\text{DSO}=\frac{\text{Average Accounts Receivable}}{\text{Credit Sales}}\times\text{Number of Days}$$

For example, a DSO of 83 days means that, on average, a company takes about 83 days to convert its credit sales into cash.

In the article, Chinese companies had a median DSO of 83 days, compared with 44 days for companies in the MSCI Emerging Markets Index. This indicates that cash was being tied up in receivables for considerably longer.

2. What does a rising DSO mean?

A rising DSO generally indicates slower collection of receivables.

In the situation described:

• Chinese companies' DSO increased from 55 days in 2010

• to 79 days in 2014

• and then to 83 days.

At the same time, accounts receivable increased by 23% over two years to about US$590 billion.

This creates a significant working-capital problem. A company may report:

Sales → Revenue → Profit

but still have:

little or no cash collected

The company therefore needs to finance its operations while waiting for customers to pay.

3. Relationship between DSO and sales fluctuations

This is particularly important when analysing the effect of fluctuating sales.

DSO is calculated using accounts receivable relative to sales, so changes in sales can affect the calculated DSO even when customer payment behaviour has not changed.

Scenario A — Sales increase rapidly

Suppose:

	Year 1	Year 2
Credit sales	$10m	$15m
Accounts receivable	$2m	$3m
DSO	73 days	73 days

Although sales increased by 50%, receivables increased proportionately. DSO remains approximately unchanged.

This suggests that the company is maintaining roughly the same collection performance.

However, the company still needs more cash to support the larger volume of receivables.

Scenario B — Sales fall but receivables remain high

Suppose:

	Year 1	Year 2
Credit sales	$10m	$8m
Accounts receivable	$2m	$2m
DSO	73 days	91 days

Here, customers have not necessarily become much slower at paying. Instead, sales have fallen while receivables have remained high.

Consequently, DSO increases.

This is important in the Chinese situation because an economic slowdown can reduce sales while previously generated receivables remain outstanding.

Scenario C — Sales increase because of aggressive credit sales

There is another possibility.

A company may increase sales by offering customers longer payment terms.

For example:

Customer previously pays in 60 days → company offers 90-day credit → sales increase.

Reported revenue may look healthy, but cash collection deteriorates.

DSO consequently rises, and the company may experience a cash-flow problem despite reporting higher sales and profits.

This is why the article refers to the possibility that companies could be "booking revenues too aggressively."

4. Why DSO was particularly important in the Chinese situation

The article describes a combination of several factors:

Economic slowdown
↓
Lower customer cash flow
↓
Customers delay payments
↓
Accounts receivable increase
↓
DSO increases
↓
Company cash inflow decreases
↓
Working-capital pressure increases
↓
Company may borrow more or delay payments to suppliers
↓
Financial stress spreads through the supply chain.

This is the knock-on effect referred to in the article.

A company with a high DSO is effectively providing financing to its customers.

For example, if a company makes $100 million of annual credit sales and its DSO rises from 60 to 100 days:

$$\text{Additional receivables} \approx 100m\times\frac{40}{365}$$ $$\approx \$11m$$

Approximately $11 million more cash is tied up in receivables, assuming sales remain constant.

5. DSO and sales fluctuations must therefore be interpreted together

A high DSO does not automatically mean poor credit control.

It should be analysed together with:

• Sales growth/decline

• Accounts receivable growth

• Credit terms

• Customer concentration

• Bad-debt provisions

• Cash flow from operations

• Inventory turnover

• Industry norms

• Economic conditions

For example:

Sales +20%, receivables +20%, DSO stable
→ collection performance may be relatively stable.

But:

Sales -20%, receivables unchanged, DSO increases significantly
→ the increase may partly be caused by falling sales rather than a deterioration in collection behaviour.

And:

Sales +10%, receivables +40%, DSO increases
→ this is more concerning because receivables are growing much faster than sales.

6. Interpretation of the article

The most important issue in the article is therefore not simply that Chinese companies had 83 days of DSO.

It is the direction and persistence of the change, combined with the growth in receivables and increasing insolvencies.

The situation suggests that some companies were effectively converting their customers' financial difficulties into their own working-capital and liquidity problems.

This also explains why a company can appear profitable on its income statement but experience serious financial difficulty because its cash has not been collected.

In simple terms:

Sales create revenue, but collection creates cash.

DSO measures the time gap between those two events. In a weakening economy, a rising DSO can therefore be an early warning indicator of deteriorating cash flow, customer credit quality and working-capital risk.

Days Sales Outstanding (DSO) measures the average number of days a company takes to collect cash from credit sales, with a higher DSO indicating slower collection and greater cash-flow pressure.

When sales fluctuate, DSO can change even if collection performance remains unchanged; for example, falling sales while receivables remain high will increase DSO, while rising sales proportionally with receivables may leave DSO stable.

In the Chinese situation, the rising DSO and growing accounts receivable indicated that customers were taking longer to pay, tying up company cash and increasing working-capital, liquidity, and supply-chain risks.