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Days Receivable Outstanding
The second and equally important component of the operating cycle is days receivable outstanding (DRO). Graphically defined in Figure 11.4 as the amount of time necessary to collect on an outstanding bill, this variable measures the speed with which customers are invoiced and payment is received. The timing of this activity and the haste with which money is then channeled back into the business are vital components of supply chain management. This activity has a major effect on the balance sheet, as swollen receivables reflect poorly on an organization. With regard to the cash flow statement, increases in receivables are recorded as a use of cash and are also a negative indicator of a company's financial health. Calculation of DRO is as follows:Average receivables/(Net sales/365)Figure 11.4: Days Receivable Outstanding
As in the case of DOI, a technical feel for the DRO metric requires an understanding of both its purpose and makeup. Conceptually similar to DOI, DRO measures the amount of time it takes to invoice customers and collect on debt. Given this fact, the goal of the metric is to once again establish a baseline and use proven tactics to continuously reduce the number.Mathematically, the exercise focuses on the reduction of the accounts receivable figure in the numerator, increasing the net sales figure in the denominator or a combination of the two. The goal is to generate the same or more sales with fewer dollars tied up in receivables or, at least, to generate more sales with the same amount in receivables. One important difference between DOI and DRO is that the numerator changes in the DRO equation from COGS to net sales. This is due to the fact that receivables are generated based on a sales price, not the value of the goods shown on the balance sheet. Use of any figure other than net sales would not be a true reflection of the days of receivables held by a company.Using the same mathematical logic behind DOI, calculation of the denominator (net sales/365) gives the daily dollar amount of sales that a company has generated over a 365-day period. When the average accounts receivable figure is divided by this daily sales figure, the result is the amount of DRO held by a company in the period under measurement.The sum of DOI and DRO measures the entire sales side of the operational process, accounting for the acquisition of assets (inventories), transformation of raw materials to finished goods, revenue generation and collection of receivables. The ability to decrease the number of days needed to complete the cycle, and thus the amount of money tied up in each additional day outstanding, is a primary element of any organization's supply chain mission.
