Lockup Days v Days Sales Outstanding (DSO) – What are the Differences?

Lockup days and days sales outstanding (DSO) figures depict the cash conversion of a business.

Lockup days tell us how quickly a company turns its inventory into cash. The DSO figures show how efficiently a company collects its accounts receivable.

Both figures are important efficiency and cash flow measurement metrics. Generally, the measures will depend on the production efficiency and debt collection system of an organization.

Let us discuss what are lockup days and DSO and their key differences.

What are the Lockup Days?

The lockup days or lockup period refers to the waiting time for an entity to collect its debts, unpaid bills, and accounts receivable.

The lockup days are directly linked with the cash flow management of an entity. If an entity takes too long to collect the cash, it will need to look towards expensive alternatives.

The lockup period includes work in progress, stock, or uncollected accounts. It means an organization should analyze all of its cash cycle components to improve its lockup days.

There is no stock for professional service organizations. Therefore, their lockup days usually comprise of work in progress and uncollected accounts receivable. However, it does not imply that a service organization witnesses a shorter lockup period.

The length of lockup days varies by industry and the nature of the business. For manufacturing industries having large production facilities, the bulk of inventory as WIP, and substantial accounts receivable, the lockup days will be longer.

For small organizations, the lockup days can range from 60 to 90 days and larger organizations could see a further lengthy lockup period.

What are Days Sales Outstanding?

Days sales outstanding (DSO) or average accounts receivable days are the time taken by an entity to collect its receivables.

It simply means the average days taken by a company to collect its dues from buyers. The term is more relevant for businesses dealing in credit sales than for businesses with a larger proportion of cash sales.

From a business perspective, DSO is the time taken to convert credit into cash. In other words, it is the number of days for which accounts receivable (AR) remains pending.

The length of DSO depends on the industry and an entity’s size. For instance, it is common for professional service organizations like finance firms to witness a high DSO.

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Similarly, a small business dealing more in cash than credit sales would witness a substantially low DSO ratio.

The DSO figure can be calculated for any accounting period. It can be used on a monthly, quarterly, or annually basis.

How Does it Work? Lockup Days and Days Sales Outstanding

The lockup days begin when an entity purchases raw material. For service entities, it begins when they confirm a work project.

It means if an entity does not possess an efficient production system, its lockup period will get higher. Then, the work in progress will face delays and further stretch the lockup period.

Since we calculate the days sales outstanding (DSO) only for accounts receivable, its length does not get affected by delays in the WIP or purchases phases. However, it certainly delays the order delivery that in turn can affect client relations, and hence a delay in DSO can occur.

The next crucial step occurs when an entity makes a credit sales delivery. Both the lockup days and the DSO get affected by the length of accounts receivable.

The average accounts receivable days depend on several factors. Client relations and work quality are the two most important factors. Therefore, if an entity holds these two points strongly, it can bring down the lockup days and the DSO.

How to Calculate it? Lockup Days and Days Sales Outstanding

We need similar input information to calculate lockup days and the days sales outstanding figures.

The formula to calculate the lockup days can be written as:

Lockup Days = [(WIP + Stock + Accounts Receivable) / Annual Sales] × 365

The formula can be easily adjusted for monthly or quarterly lockup period calculations. For quarterly calculations, the denominator can be 120 days and for monthly calculations, it can be 30 days.

The DSO figure requires calculating the accounts receivable figure first. For public companies, the figure is readily available in its published financial statements.

Next, you’ll need the net credit sales figures. Divide the AR figure by the net credit sales and multiply the result by the number of days for the accounting period.

The number of days can be monthly, quarterly, or annual figures depending on the analysis.

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We can use the DSO formula as below:

Days Sales Outstanding = (Accounts Receivables / Net Credit Sales) × Number of Days

Examples

Let us consider a couple of simple working examples.

Lockup Days

Suppose a company ABC has the following data available for the last month for its accounts receivable, WIP, and inventory stock.

  • Work in Progress = $ 30,000         
  • Inventory Stock = $ 45,000             
  • WIP = $ 35,000
  • Total Sales = $ 90,000

Therefore, we can calculate the lockup days as:

Lockup Days = [(WIP + Stock + Accounts Receivable) / Monthly Sales] × 30

Lockup Days = [(35,000 + 45,000 + 30,000)/90,000] × 30

Lockup Days = 36.66 days

Days Sales Outstanding

Suppose a company ABC has the following data available for the last month for its accounts receivable and net credit sales.

  • Total Sales= $ 500,000      
  • Accounts Receivable = $ 200,000

Days Sales Outstanding = (Accounts Receivables / Net Credit Sales) × Number of Days

Days Sales Outstanding = ($ 200,000/$ 500,000) × 30 = 12 days

Cash Flow Management and Lockup Days

As we can see from a simple working example above, if the entity does not improve its lockup period, it will face cash flow management challenges.

For instance, in our example, the entity ABC would take approximately 36 days to convert its inventory into cash. This figure is too high for a monthly calculation.

The consequences of holding credit sales and accounts receivable for too long are risky for any business. In the absence of internal cash flow, an entity would look towards external financing.

Debt financing to fund working capital and other operational needs can incur high interest costs. It would also further pressure the cash flow of the business.

One of the key factors to consider here is that the lockup period links both internal and external factors. A business must look inwards to improve production and work efficiency.

Also, the external clients’ relations would affect the lockup days.

Cash Flow Management and Days Sales Outstanding

The DSO ratio depends on the outstanding accounts receivable figure. Businesses making credit sales will witness a higher DSO figure usually.

If a company has a high DSO ratio, it will face significant cash flow challenges. That in turn will impact its working capital management and short-term liquidity.

Again, a business struggling to collect accounts receivable in time will look for external finance sources. Beyond a certain limit, debt financing will push the interest costs higher and marginalize the cash flow further.

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Lockup Days Vs Days Sales Outstanding (DSO) – Key Differences

Both figures represent the similar metrics to evaluate the critical components of the cash cycle.

The lockup days are more inclusive as they include work in progress, inventory stock, and accounts receivable days.

Contrarily, the DSO figure only considers credit sales made and the accounts receivable for the accounting period only.

It means the difference lies between including internal efficiency, supplier relations, and credit policies in the lockup days. The DSO figure largely depends on client relationships and the quality of products/services.

When evaluating the lockup days, an entity must begin with the availability of raw materials. Then, the production efficiency and inventory stocks. Thus, it must link the internal and external factors affecting the cash cycle.

On the other hand, the DSO analysis would begin with the analysis of credit sales. An entity would evaluate its credit policies for appropriateness. Then, it would evaluate its cash collection process from the clients.

In short, the lockup period is more inclusive as it includes internal and external factors as compared to the DSO figure that only considers debt collection.

How to Improve the Lockup Days and Days Sales Outstanding?

Accounts receivable is a constant figure in both calculations. Therefore, the most important factor is to shorten the accounts receivable period.

A company should consider the following factors to improve its lockup days:

  • Increase the production efficiency
  • Improve WIP and Stock inventory periods
  • Improve accounts receivable collection
  • Negotiate better credit terms with suppliers and clients effectively
  • Invoice more often and use a specialist debt collector
  • Change payment terms with the clients when needed

Similarly, the following points can help in improving the DSO figure:

  • Improve accounts receivable collection system
  • Offer pricing incentives, discounts, for early payments
  • Offer easy and simple payment methods to clients
  • Introduce different payment plans
  • Analyze client profiles carefully and discard clients with bad credit
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