One of the most critical metrics for assessing the efficiency of your company's cash flow management is Days Sales Outstanding (DSO). A lower DSO indicates that a company is more effective at collecting its receivables and maintaining healthy cash flow. Reducing DSO can significantly enhance your company’s liquidity, reduce financial risk, and improve overall profitability.
In this blog we’ll explore some best practices and strategies to help you effectively manage and reduce your DSO. You’re probably already doing some of these practices, but you may not be doing them with the level of streamlined efficiency that’s easily attainable. If you’re still using manual processes with disparate systems and accounts to manage your accounts receivable, then it’s a certainty there’s room for improvement.
Understanding Days Sales Outstanding
Before we get into strategies, it’s important to understand what DSO is and how it’s calculated. DSO measures the average number of days it takes for a company to collect payment after a sale has been made. It is calculated using the following formula:
DSO = Accounts Receivable Balance x Number of Days / Revenue
Say a business has an AR balance of $30,000 and $200,000 in revenue. Using the above formula, divide $30,000 by $200,000 and you get .15 or 15%. Then divide by 365 days and you get approximately 55 for Days Sales Outstanding. What this means is that once this business has made a sale, it’s waiting about 55 days to collect the payment.
A high DSO indicates that your customers are taking longer to pay, which could strain your cash flow. Conversely, a low DSO suggests you’re following efficient collection practices and overall better cash management.
Best Practices for Reducing DSO
-
Implement a Robust Credit Policy
Establishing a clear and comprehensive credit policy is fundamental to managing your DSO. This policy should include:
- Creditworthiness Evaluation: Before extending credit, assess the creditworthiness of your customers through credit reports, financial statements, and trade references.
- Credit Limits: Set appropriate credit limits based on the customer’s ability to pay and their financial history.
- Payment Terms: Define clear payment terms, including due dates and discount offers for early payment.
-
Streamline Invoicing Processes
Efficient invoicing practices can have a significant impact on reducing DSO. Consider the following steps:
- Accuracy: Ensure that invoices are accurate and complete to prevent delays caused by disputes or errors.
- Timeliness: Send invoices promptly after goods or services are delivered. Delays in invoicing can result in delayed payments.
- Format: Use professional and clear formats for invoices. Make sure payment terms, due dates, and contact information for queries are clearly displayed.
-
Utilize Technology for Automation
Leveraging technology can transform your accounts receivable management. Implementing automated systems can help:
- Automated Invoicing: Use accounting software to automate invoice generation and delivery–or better yet, use a cash management platform that’s powered by artificial intelligence (AI).
- Electronic Payments: Offer multiple payment options, such as credit card payments or electronic transfers, to make it easier for customers to pay.
- Reminders and Follow-Ups: Set up automated reminders for upcoming due dates and overdue payments.
-
Enhance Collection Efforts
Active management of your receivables can significantly impact your DSO. Consider these strategies:
- Regular Follow-Ups: Establish a consistent follow-up schedule for overdue accounts. Early intervention can prevent accounts from becoming significantly overdue.
- Dedicated Collections Team: If feasible, have a dedicated team or individual responsible for collections. This team should be well-trained in negotiation and customer communication.
- Incentives for Early Payment: Offer discounts or incentives for customers who pay before the due date.
-
Negotiate Better Payment Terms
Review and negotiate payment terms with your customers to better align with your cash flow needs:
- Shorter Payment Terms: Consider negotiating shorter payment terms for new contracts or renewals.
- Flexible Payment Plans: Offer flexible payment plans for customers who may need more time to pay but are otherwise reliable.
-
Monitor and Analyze DSO Metrics
Regularly monitor your DSO metrics to identify trends and areas for improvement:
- DSO Reports: Generate and review DSO reports frequently to track performance and identify problematic accounts.
- Customer Segmentation: Analyze DSO by customer segments to pinpoint which segments are causing delays and adjust your strategy accordingly.
-
Build Strong Customer Relationships
Maintaining positive relationships with your customers can facilitate smoother collections:
- Clear Communication: Foster open communication regarding payment terms and expectations.
- Customer Support: Provide excellent customer service to enhance customer satisfaction and reliability.
- Address Disputes Promptly: Resolve any disputes or issues promptly to prevent delays in payment.
-
Review and Adjust Credit Policies Regularly
Periodically review your credit policies to ensure they remain effective and relevant:
- Market Changes: Adjust credit policies based on changes in market conditions or customer behavior.
- Performance Metrics: Use DSO trends and collection performance metrics to make informed adjustments to credit policies.
-
Leverage Data Analytics
Data analytics can provide valuable insights into your receivables management:
- Predictive Analytics: Use predictive analytics to forecast potential payment delays and adjust your strategies accordingly.
- Historical Data: Analyze historical data to identify patterns and trends in customer payment behavior.
-
Seek Professional Advice
If reducing DSO proves challenging, consider seeking advice from financial consultants or experts:
- Consultants: Financial consultants can provide tailored strategies and solutions for managing receivables and optimizing cash flow.
- Training: Invest in training for your accounting and collections teams to enhance their skills and effectiveness.
- Vendors: Don’t overlook the value of meeting with AR automated software providers. Yes, they will have an underlying objective (make a sale), but you can glean helpful tips and insights from their experience.
Reducing Days Sales Outstanding is crucial for maintaining a healthy cash flow and ensuring the financial stability of your company. By implementing best practices such as establishing a robust credit policy, streamlining invoicing processes, enhancing collection efforts, and regularly reviewing your strategies, you can effectively manage and reduce your DSO.
It may sound like a complex and time-consuming endeavor, but it doesn’t have to be complicated. In fact, by implementing one of the best practices (utilizing technology for automation), you can effectively follow most of the strategies in one fell swoop.
>>> For example, the right AR automation tool can help with the following:
- Streamlined invoicing–by automatically gathering sales data rather than waiting on manual entry, the process is significantly faster and more accurate. An invoice can be generated and sent to the customer within minutes of the transaction instead of days.
- Improved collection efforts–faster invoicing, automatic payment reminders and late notices, a customer self-serve payment portal with a menu of payment options–all these factors accelerate collections and improve cash flow.
- Enhanced monitoring DSO and other metrics–by connecting all disparate systems and providing financial data in real-time, you’ll have the most current information you need instantly to make better informed decisions.
- Strengthened customer relationships–customers appreciate the timely, consistent professional communications that AR automation tools offer. They also prefer to have payment options and an easy way to make electronic payments.
- Harnessed data analytics–your cash forecasting and other AR tasks are dramatically improved when you rely on AI-driven cash management software to use predictive analytics and historical data.
Embracing these strategies through automation and keeping a tight check on your credit policies with regular reviews will not only reduce your DSO, it will enhance your cash flow and also contribute to the overall success and growth of your business.
Payference is an all-in-one cash management platform that leverages AI to increase efficiency in AR processes. It was designed especially for small to midsize businesses to provide the advanced tools you want without all the extra enterprise-level features you don’t need–or want to pay for.
If you’d like to learn more about reducing your Days Sales Outstanding and all the many ways Payference can help your business grow, schedule a demo today.