Chartered Financial Analyst (CFA) Level 1 Practice Exam

What does Days Sales Outstanding indicate?

1. Average number of days to collect receivables

2. Number of sales made on credit

3. Days in accounting period / inventory turnover

4. Time taken for inventory turnover

The correct answer is: Average number of days to collect receivables

Days Sales Outstanding (DSO) is a financial metric that quantifies the average number of days it takes for a company to collect payments from its credit sales. It is an important measure of how effectively a company manages its accounts receivable. A lower DSO indicates that a company is able to collect its receivables more quickly, which is a sign of strong cash flow management and financial health. In calculating DSO, the formula typically used is (Accounts Receivable / Total Credit Sales) multiplied by the number of days in the period. This calculation provides insight into the efficiency of a company’s credit policies and collection processes, allowing management to assess their credit risk and working capital needs. While the other options touch on aspects of sales or inventory management, they do not accurately reflect what DSO represents. For instance, the second option refers to credit sales volume rather than collection efficiency, while the other two options relate to inventory turnover, which is not relevant to the measure of accounts receivable collection. Thus, the selection of the average number of days to collect receivables as the correct interpretation of Days Sales Outstanding is accurate and essential for understanding a company's operational performance.