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Cost of DSO
Posted on 3/2/11 at 5:29 pm
Posted on 3/2/11 at 5:29 pm
I need some help calculating the cost of excessive DSO (days of sales outstanding) for specific clients.
I think I'm clear on calculating the cost of a single unit of DSO on an annual basis: Client's Avg Sales $$ Day X my company's WACC. Am I correct in this calculation?
Assuming that's correct, I'd like to take it a step further and assess the potential cost of DSO for a specific client over a 2 year contract. To do this, do I just multiply the calculation above for that client by 2?
I hope this makes some sense. Any help would be appreciated.
I think I'm clear on calculating the cost of a single unit of DSO on an annual basis: Client's Avg Sales $$ Day X my company's WACC. Am I correct in this calculation?
Assuming that's correct, I'd like to take it a step further and assess the potential cost of DSO for a specific client over a 2 year contract. To do this, do I just multiply the calculation above for that client by 2?
I hope this makes some sense. Any help would be appreciated.
1
Posted on 3/2/11 at 5:34 pm to Pheeze
quote:
Client's Avg Sales $$ Day X my company's WACC. Am I correct in this calculation?
wouldn't it be: (Avg Sales $/Day)x (average days outstanding)x(wacc)?
quote:
To do this, do I just multiply the calculation above for that client by 2?
(Avg Sales $/Day) x (average days outstanding) x (wacc) x (2)
I believe.
We have a few CPA's around here that might be more correct than I am.
Posted on 3/2/11 at 6:29 pm to TheHiddenFlask
quote:
wouldn't it be: (Avg Sales $/Day)x (average days outstanding)x(wacc)?
Essentially - but originally I was just calculating the unit cost (per day of DSO)
Posted on 3/2/11 at 7:16 pm to Pheeze
Is your DSO being calculated using average AR over the two year contract period?
Posted on 3/2/11 at 7:26 pm to Pheeze
quote:
Essentially - but originally I was just calculating the unit cost (per day of DSO)
Okay, that was right then.
But if you want to do it for two years, then use my formula times 2
Posted on 3/2/11 at 7:27 pm to sneakytiger
quote:
Is your DSO being calculated using average AR over the two year contract period?
Yes - I'm calculating a historical DSO in order project a future cost of DSO. My reasoning is that if a certain client has some historical DSO they are likely to sustain that behavior in the future. If I'm about to sign a 2-year contract with that client then I want to understand what my cost to finance their DSO will be.
Posted on 3/2/11 at 7:30 pm to TheHiddenFlask
quote:
But if you want to do it for two years, then use my formula times 2
That was my original thought as well but something just doesn't feel right about that. Not sure why it just seems like I'm not accounting for some compounding effect.
Posted on 3/2/11 at 7:34 pm to Pheeze
Yeah I think your formula is right then... only other comment is would you need to include some sort of discount factor for the year 2 cash flows? 
Posted on 3/2/11 at 7:37 pm to Pheeze
quote:
That was my original thought as well but something just doesn't feel right about that. Not sure why it just seems like I'm not accounting for some compounding effect.
That was my thought as well. I still feel like that's something I am missing, but I am pretty sure I am right.
I think the thing is that it's just straight cost, so it's not compounding. If you want to use compounding interest, it would actually be working to shrink the PV of the future cost, because it's not realized until the future dates. I think.
Posted on 3/2/11 at 9:58 pm to TheHiddenFlask
Why wouldn't you just take the AR balance and discount it by your WACC? Wouldn't the DSO just tell you how to compound your WACC?
EG: Your boy has 500 in AR and his DSO is 90, WACC 8%. The PV of your DSO is the 500/(1+WACC^(1/4)), where 1/4 is 90/360, so 490. Your cost per 90 days outstanding is 10.
EG: Your boy has 500 in AR and his DSO is 90, WACC 8%. The PV of your DSO is the 500/(1+WACC^(1/4)), where 1/4 is 90/360, so 490. Your cost per 90 days outstanding is 10.
Posted on 3/2/11 at 10:47 pm to kfizzle85
quote:
EG: Your boy has 500 in AR and his DSO is 90, WACC 8%. The PV of your DSO is the 500/(1+WACC^(1/4)), where 1/4 is 90/360, so 490. Your cost per 90 days outstanding is 10.
That's right. Thanks for that, it was bugging me.
Posted on 3/2/11 at 11:40 pm to TheHiddenFlask
To go all the way with it, I would suggest that if the customer is an above average risk (as an example, if his DSO is higher than avg DSO, or if you know some deets on their fin sitch), using company WACC is prob not the best measure, and should be risk adjusted for that customer.
/CorpFinGradClass
/CorpFinGradClass
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