Days Sales Uncollected

The days' sales uncollected, also known as the average collection period. One liquidity ratio is measured to estimate the days before collecting receivables. Creditors and investors use the ratio to determine the company's short-term liquidity. The days' sales uncollected ratio formula measures how long it will take for customers to pay their credit card balances.

The days' sales uncollected is an important ratio for the company's investors and creditors, which helps measure the days the company will receive the cash for its sales. It is calculated by dividing average accounts receivable by the net sales and multiplying the result with the total number of days in a year.

• The days' sales uncollected is an essential ratio for the company's investors and creditors. 
• It determines the days the company may obtain the cash for its sales. 
• One may calculate it by dividing the average accounts receivable by the net sales and multiplying the result by the total number of days in a year.
• It displays the collection department's success. It is primarily affected by external factors such as whether the client's business is robust or the business condition.

The term day sales uncollected is also known as day sales outstanding or accounts receivable days. It is a very commonly used financial metric, that can assess the average number of days the business may take to collect its payments from the customers who have purchased goods from them. The sales are assumed to be made on credit.

This metric of days sales uncollected ratio is a very valuable indicator of the efficiency level of the company and signifies how well the management is able to successfully make sales and collect its payments or accounts receivable on time. Receipt of payments without much delay and within the credit period helps business to maintain a steady flow of cash which is essential for smooth running of operations. If revenue generated from sales are blocked, it not only signifies the company’s inefficiency to collect the payment but also leads to lack of liquidity that is required to  meet its daily expenses.

Generally, days sales uncollected ratio below 45 days considers low as it depends on business type and structure. So, there is no ideal ratio. The unusually high figure depicts a casual credit policy or inadequate collection process. It could be possible because of the slow economy where customers cannot pay.

Another point to consider is seasonality. The business sales may vary from month to month. So, the receivables figures in the numerator may not be a true picture of a particular period or the entire year. Also, consider the distribution. Some of the receivables could be overdue for a long time, which may impact the measurement. But, again, the notation can be useful in this regard.

We can conclude that days' sales are uncollected and widely used for collections and credit management. It assists with cash flow planning. It is an indicator of the success of the collection department. It is largely affected by external factors like whether the client's business is powerful or the business condition. It is very important to check the ratio as it is an indicator of the liquidity and solvency of the organization.

There are various components in the calculation of the number of days sales uncollected. Let us look at the components and understand them in detail.

#1 – Accounts Receivable

Accounts receivable is the proceeds of payments due to the company for its credit sales to its customers. When a company extends credit to the customer, it provides a period to the customer for payment. As a result, the sales realize when the invoice generates.

#2 - Net Sales

Net sales are the company's gross sales after returns, discounts, and allowances. Revenues reported on the income statement often represent net sales.

Days Sales Uncollected Formula

The days' sales uncollected ratio divides accounts receivable by net sales and multiplies it by 365. One can express number of days sales uncollected as: -

The result expresses in days.

Inputs:

1. One can pick up accounts receivable data from the balance sheet.
2. The company must provide credit sales. They rarely report in the separate head in the income statement.

Implication:

• One can use cash for different operational activities collected sooner. With lower days sales uncollected, liquidity and cash flows tend to increase. It also depicts that accounts receivable are not bad debts but are good.
• A higher ratio shows the non-suitable collection process. Also, customers are not able or unwilling to pay. As a result, such companies face problems in converting sales into cash.

Below are the examples of days sales uncollected as follows: -

Example 1:

Suppose ABC Ltd. is a U.S.-based company. At the end of March 2018,

• Accounts Receivable=$400,000.
• Net Credit Sales=$3,600,000.

So, the days’ sales uncollected will be,

Days’ Sales Uncollected Formula = Accounts Receivable/Net Sales * 365

= 40.56~ 41 days.

So, ABC Co. will require approximately 41 days to collect the receivables. So from the above example we understand how to find days sales uncollected.

Example 2:

Suppose Doro's Pine Boards is a UK-based retailer offering customers credit. Doro sells inventory to customers per the credit policy, wherein customers will pay within 30 days. Some customers pay promptly, but some make a delayed payment. Financial statements have the following details: -

• Accounts Receivable: £11,000
• Net Credit Sales: £131,000

Now let us see how to find days sales uncollected.

Days’ Sales Uncollected Formula = Accounts Receivable/Net Sales * 365

=30.65 days~ 31 days

The company takes 31 days to collect cash. So, it is a good ratio similar to its set standard.

The above examples clarify the financial concept in detail and show us the method to calculate days sales uncollected used by the management to keep track of the collection made so that there is no delay in receiving the funds.

Like every financial concept has both advantages and disadvantages, so does this concept to calculate days sales uncollected. Let us try to identify the advantages first.

• If a department store or any organization sells its goods and services to its customers or clients on credit, they ultimately sell more products. So, they have large accounts receivable on their books, which is a good sign for their financial performance.
• Apart from liquidity, the ratio can be used for management to estimate the effectiveness of credit and collection activities.
• It can be used as a tool for peer creditors to give products on a credit basis if one creditor finds a customer or party not creditworthy. It can work as a warning for others too.
• It can indicate if the company is maintaining customer satisfaction or if credit is given to customers who are not creditworthy.

Some important disadvantages of the concept are as follows.

• A high ratio shows that the company is taking longer to collect money, which may lead to cash flow problems.
• Suppose a company's payment of expenses is directly dependent on payments from accounts receivable. A sharp rise in the ratio can disrupt this flow, and one can require drastic changes.
• Suppose a company has a volatile days sales uncollected ratio. That may cause concern, but there is no issue if a company's ratio dips during a particular season each year.

If we consider the efficiency of a business, days sales uncollected come with a set of limitations that are important for any investor to notice: –

• When companies are compared based on the ratio, one must do it in the same industry to have similar business models and revenue. Companies of different sizes often have other capital structures, influencing calculations.
• The ratio is not useful in comparing companies with significant differences in the proportion of credit sales.
• The ratio is not a perfect indicator of a company's accounts receivable efficiency, as it depends on the volume and frequency of sales. Therefore, one must use days sales uncollected along with other metrics.
• It only accounts for credit sales. It ignores cash sales. If they factored them into the calculation, they would decrease the ratio.

It is important to understand the fact that the value can change depending on the business model or the industry condition. In the business is such that the sales process takes a long time or the condition of the financial condition of the economy as a whole is weak, then it influences the collection period. Managements often compare the historical data of the collection process to estimate how well the business is operating and also gives insight into the liquidity position and financial performance.

This article is a guide to what is Days Sales Uncollected. We explain its components, with example, advantages and disadvantages. You may learn more about accounting from the following articles: -

• Days Sales Outstanding Formula
• What is Debtor Days Formula?
• Formula of Days Inventory Outstanding 
• Calculate Gross Sales