Days Sales Outstanding (DSO) is a common measure for how long it takes a company to collect on an invoice. And after years of supplier shortages, drastic demand fluctuations, increased operating costs and liquidity pinches, finance leaders are prioritising goals associated with reaching the lowest DSO possible and quickly recovering payment on accounts receivable (AR). 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:
DSO = (AR balance / Credit sales) x Number of days in that period
For example, if your net credit sales (sales that aren’t 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 aging 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?
Going beyond DSO to optimise cashflow
Improving DSO is imperative to cash management; however, there are two sides to the cashflow coin: AR and accounts payable (AP). Both play equally integral parts in establishing cashflow, and when it comes to improving it, addressing only one of these processes simply isn’t enough to create real change. The only way to do that is by strengthening both muscles: the one bringing cash in (AR) and the one sending cash out (AP).
On the flipside of DSO is DPO (Days Payable Outstanding), and like DSO it can pack a major punch when it comes to cashflow performance. DPO can also be the determining factor between suppliers considering your company a “good client” or a “bad client”. There’s currently no benchmark for a “healthy” DPO due to the variability of industry, competitive positioning and bargaining power of organisations. That’s why keeping a close eye on your DPO and your competitors’ DPO is important for gauging your payables performance.
Addressing both sides of the cashflow coin
Automating just one side of the cashflow equation can actually create new inefficiencies. Because AR and AP processes are inextricably intertwined, automating just one can result in departmental silos and ultimately hinder your ability to optimise working capital.
The secret sauce to a better DSO and DPO is automating both AR and AP through a single interface that simplifies and standardises you organisation’s finance function as a whole. Want to learn more about end-to-end financial transformation? Check out this ebook!
-Written by, Diana Eagen