Days' sales uncollected is a liquidity ratio that is used to estimate the number of days before receivables will be collected. This information is used by creditors and lenders to determine the short-term liquidity of a company. It can also be used by management to estimate the effectiveness of its credit and collection activities. The formula is:
(Accounts receivable ÷ Net annual credit sales) x 365 = Days sales uncollected
For example, a company has $400,000 of accounts receivable outstanding as of the end of March. For the 12 months ending in March, the company had sales of $3,600,000. This means that the days' sales uncollected is 41 days, which is the approximate time period required to collect the receivables.
An unusually high figure in proportion to the standard days allowed to pay indicates either an issue with lax credit standards or inadequate collection activities. It could also relate to a downturn in the economy that is impacting the ability of customers to pay. There are several issues with the days' sales uncollected measurement to be aware of, which are as follows:
Seasonality. The sales level of a business may change substantially by month. Since the measure is designed to be on an annualized basis, the amount of receivables included in the numerator may not reflect the average receivables level for the entire year. To correct for this issue, annualize the sales for the past quarter and use that in the denominator instead of the full-year net credit sales.
Distribution. Some of the outstanding receivables could be extremely overdue, which drags down the outcome of the measurement. It can be useful to accompany the measurement with a notation regarding the aggregate total of receivables more than 60 or 90 days old, to give the reader a sense of the extent of this problem.