Days Sales Outstanding (DSO) is a common measure for how long it takes a company to collect on an invoice. The goal is to reduce DSO to have the lowest DSO possible and quickly recover payment on accounts receivable (AR). A high DSO value means it takes a company a lot longer to collect and could lead to cash flow problems due to the longer time between the sale and the time the payment is received.
DSO is calculated using the following formula:
For example, if your net credit sales (sales that are not paid immediately) are $950,000 and your AR balance is $125,000 for a year-long period, it takes you an average of 48 days to collect from your customers. If you have 30-day payment terms, this number means you need to speed up the rate at which you receive payment.
DSO = ($125,000 / $950,000) × 365 days = 48
A high DSO has a tremendous impact on cash flow and revenue and can prohibit you from investing in your company’s growth. Reducing DSO, even slightly, can go a long way toward improving financial health. There are several strategies to reduce DSO and improve an organisation’s cash flow, such as:
- Make it easier for your customer to do business with you
Offering multiple payment methods — such as credit cards and automatic payments, or an online option for customers to view invoices and statements — provides greater flexibility for the customer and improved cash flow for you. Are you making it easy for your customers to pay and communicate with you? Check out Esker’s payment portal.
- Stricter credit approval
Are you performing credit evaluations on all new customers? Are your credit terms appropriate and followed by your sales department? Does your customer service department flag new orders that do not have a completed credit app? Do you have a procedure in place for updating credit information on a regular basis?
Are your invoices accurate and sent out on time? Are payment terms and due dates clearly written on invoices and any other communication sent out to the customer? Have billing addresses and accounts payable email addresses verified before bills are sent out? Do you provide incentives for early pay? Are you sending out automated payment reminders?
- Receivables management strategy
Do you consistently follow up on customer disputes and late payments? Are you measuring performance against goals? Do you regularly review ageing reports? Are you reporting on collections forecasting? Do you have an understanding as to why customers are paying late (e.g., invoice discrepancies, product issues, etc.)?
Do you have a collections process in place? Do employees have the tools they need to prioritise, call and email collection efforts? Are they well trained? Do they have enough time to follow up on all past-due accounts? Are they able to efficiently keep sales and customer service in the loop on disputed invoices?
Are you offering discounts? Do you offer incentives to customers to receive quicker payments, such as early payment discounts? For example, you could offer a discount for paying within a week or 10 days when your payment terms are net 30. This discount can be easily offset by speeding up cash flow, savings on loan fees and better discounts from creditors.
- Customer purge
No one wants to walk away from a customer, but do you know which customers are routinely inconsistent, unresponsive or continually paying invoices late despite offering outstanding services? Has your company considered dropping bad customers from your business list? DSO increases are often driven by a few large customers. Has your collection staff worked closely with those customers to understand what is driving the slippage?
DSO is the most widely used measurement utilised by credit and AR professionals to analyse the success of their collection efforts. The more quickly you collect, the better your cash flow situation will be … and a small improvement to reduce DSO can go a long way!