A company’s cash flow is a critical factor for its success. Collecting outstanding accounts receivable will help keep the cash flowing. One method for evaluating how efficient your accounts receivable processes are is by measuring Days Sales Outstanding (DSO). Here is a review of DSO, its significance to your company, and how you can lower it.
What is DSO?
This measurement is the average number of days it takes a company to collect payment after it has made a sale on credit. It is often referred to as the average collection period. It’s calculated by dividing the amount of accounts receivable during a given period by the total value of credit sales during that period, then multiplying the result by the number of days in that period. The lower the number, the quicker you will likely be paid.
DSO reflects the size of a company’s outstanding accounts receivable. It is most important for companies that rely heavily on accounts receivable for their cash flows. Usually, when looking at a company’s cash flow, it’s important to track the DSO over time to see whether it’s trending in any direction or if any patterns are apparent in the company’s cash flow history.
By analyzing trends and knowing how many days your sales remain unpaid, you can better evaluate your credit terms, invoicing practices, and financial projections.
Why is DSO significant?
Cash flow is the lifeblood of any business. Without a steady flow of incoming revenue, a business will simply wither and die. Many businesses fail to understand how carrying a high DSO can impact their overall cash flow. For example:
- It limits a company’s ability to reinvest profits in growth.
- Accounts more than 120 days overdue are unlikely to ever be paid off.
- The time and effort spent on debt collection could be better spent on core business activities.
- You may have to borrow to bridge the gaps when cash flow falls off.
You’ve analyzed your DSO over time and realize that your DSO is significantly affecting your cash flow. It’s important to take steps to lower your DSO and protect that valuable asset. Here are some strategies for doing so:
- Reevaluate credit practices and payment terms: Do you need to reduce the amount of time payment is due? Can you offer incentives for early payment or institute penalties for late payments? Also review your credit risk management practices.
- Invoice quicker: You may want to invoice as soon as the product ships or use electronic invoicing to automate the entire process.
- Improve your collections practices: Closely monitor your accounts receivable, and be proactive with gentle reminders. If a debt remains unpaid for an unacceptable period, it might be best to turn it over to a collection agency.
DSO can be a valuable measurement of how effective your credit policies and accounts receivable collection practices are. It is also a key influencer of cash flow — your company’s life blood. If you have a high DSO, it might be time to look at your overall credit risk management practices or partner with a financial services company that can help reduce your DSO and optimize your cash flow.