No matter what business you are in, every organization needs cash flow to cover day-to-day costs, pay staff, or settle loans. So, getting paid on time and managing your cash flow is key to growing a successful business. In a perfect world, every business would collect payment for their receivables faster than they have to pay their payables. As this is often easier said than done, there are some strategies your business can deploy to help navigate and improve cash flow.
Let’s start by doing the math. Do you know your organization’s DSO? Days sales outstanding or DSO is the common measure for how long it takes a company to collect an invoice. This is a simple equation that shows you the average number of days your receivables are outstanding.
DSO can be calculated using the following formula:
DSO = (Accounts Receivable / Total annual sales on credit) X 365 days
Knowing, tracking, and controlling your organization’s DSO is an important component in the overall management of a business’s cash flow. You want to reduce your DSO to the smallest number possible. Why? As a company's DSO value decreases, its liquidity and cash flow increases. A low DSO proves especially beneficial for small to medium-sized businesses where fast credit collection means the money can be used sooner and excess money collected can be immediately reinvested in order to increase future earnings. A higher DSO means that money owed to you is not as available to fuel your business and, in some cases, you may even have to obtain external financing to compensate for this delay.
Higher or Lower and why it matters
A DSO of around 45 or below is often considered low, however, this is a generalization and will vary depending on business type and structure. The best way to know how your DSO stacks up is to benchmark against other organizations in your industry. There is a great chart here comparing the DSOs of different industry sectors in various countries around the world. Also, see the chart below.
A higher DSO number will indicate you have a longer than average collection period from customers which in turn could have a tremendous impact on your cash flow. High DSOs have a significant impact on smaller businesses that rely on fast collection. A lower DSO number indicates a company is taking less time to collect payment with customers paying on time or even early, suggesting an organization is sitting in a higher cash flow situation.
How to Reduce your DSO
Anytime you make it easier or beneficial for a customer to pay on time or early you set your business on the path to success, these strategies below can be implemented to reduce your organization’s DSO and improve your company’s cash flow.
Timely billing: The easiest way to cut down and reduce DSO is through lightning-fast invoicing processes. Accounts receivable (AR) automation takes the entire traditional resource-intensive AR process and seamlessly transfers the administrative burden to technology, not only freeing up employee’s time and resources, but helps get you paid faster.
Invoicing: Ensuring your invoices are accurate and sent out on time with payment terms and due dates clearly stipulated. Automated payment reminders can free up time the accounts receivable spends chasing down payments and allows for invoice and payment follow up customization.
Options: These days convenience is everything and as one-click payments have become the norm, offering multiple payment methods such as credit cards and automatic payments delivers greater flexibility and convenience for the customer and delivers improved cash flow for you.
Incentives: Offering up discounts or incentives for customers will often ensure payments are paid on time or even earlier. Early payment discounts offered can be easily offset by speeding up cash flow, savings on loan fees and better discounts from creditors.There’s no doubt, DSO is a critical measure for determining how much cash you can expect to have on hand. Taking the time to evaluate and improve collections, and further analyzing the success of your collection efforts process can go a long way to ensuring a long term profitable business.