When it comes to business cash is like blood, you need it to be pumping around your company’s arteries in order to remain healthy and allow it to grow. A high DSO (Daily Sales Outstanding) can certainly curtail that growth and whilst there are some fantastic training courses out there, and the internet is awash with collection strategies designed to improve cash flow, the simple fact remains that the quicker you collect payment for the goods or services provided, the healthier your business and it’s cash flow will be.
But whilst much thought is given to ways in which cash flow can be increased, quite often there is less thought or even no thought at all given to the true cost of having a high DSO and the negative impact this has on the profitability of the business. This blog will offer an insight, or to some, a reminder of the importance of maintaining a low DSO, and provide a few pointers on how to reduce your Daily Sales Outstanding.
Daily Sales Outstanding Explained
So what actually is Daily Sales Outstanding (DSO) and how is it calculated?
DSO is the average number of days that it takes for you to collect the cash following a sale made on credit. A low DSO number means that it takes a business fewer days to collect it’s accounts receivable. A high DSO number means that following the sale of goods or services it is taking longer for customers of that business to pay.
There are several methods of calculating DSO, a common formula used is as follows:
- Accounts Receivable (DIVIDED BY)
- Total Credit Sales (TIMES BY)
- Number of days (TIME PERIOD EXAMINED)
For example, in the month of April the business made a total of £500,000 in “Credit Sales” and had an amount of £350,000 outstanding in “Accounts Receivable”. There are 30 days in April so the businesses DSO for that month could be calculated as:
350,000 ÷ 500,000 = 0.7 × 30 (days in April) = 21 days giving a DSO of 21.
A DSO below 45 would generally be considered as low, however there are factors such as the business type and company structure that would determine what is a high or low DSO.
How a high DSO can reduce your profits
It goes without saying that there are obvious disadvantages to being paid late, and the law of diminishing returns certainly applies in the case of overdue invoices.
Invoices that go beyond 120 days overdue are significantly less likely to be paid, subsequently leading to a loss in revenue, and in most cases actually costing your business money. Expenses relating to bank charges and overdraft fees are often overlooked, but in most cases these fees could be avoided if the business had more cash at their disposal. Furthermore, businesses with a high DSO and a lack of liquid assets may find themselves struggling to maintain their monthly operational costs, and as a result, may resort to outside financing leading to interest being charged, which again eats into the bottom line.
There are the operational costs associated with chasing and recovering overdue debts too. As debts age there is a propensity for invoices to be queried, and although a resolution could result in payment being made, collectively it could take several hours and require input from multiple members of staff across various departments in order to reach the desired outcome – which is time and resource that might not have been factored into the price quoted when making the sale.
If your business is not utilising our Online Payment System copy document requests can also sap resource and impact greatly on the businesses ability to collect payments as they fall due. Dealing with high volumes of copy document requests can often prevent controllers from contacting customers prior to the due date to ensure that the invoice has been received, there are no issues, and that the invoice is in the customers system ready for payment. Having the time and ability to undertake this “pre-due” activity will certainly contribute to a reduction in DSO, and with the use of our Online Payment System fewer queries will be received which will undoubtedly free up more time for your business to focus on cleaning up the back end of the ledger.
Fewer queries, coupled with greater levels of efficiency could mean your business has the opportunity to run leaner than before, leading to a reduction in operating costs and higher levels of profit.
Where it is necessary for debts to be referred to a 3rd party for collection, a commission may be charged to you. Solicitors costs and Court fees may also be incurred where litigation is required. And although some of the fees charged can be recovered, there is a chance that they will not be, thus resulting in additional costs to the business.
Incurring these additional recovery costs and having less cash readily available as a result of a high DSO can be a factor in your businesses ability to grow. Whether growth is achieved through acquisition or through the hiring of additional resource, having greater levels of cash at your disposal will allow the business to be more flexible, grow at a rate that reflects the ambitions of the business, and move more swiftly on opportunities that present themselves.
How to reduce your DSO
Reducing the businesses DSO and understanding the benefits of doing so is much like dieting, and like diets we tend to start off with a target figure in mind and then set about achieving that goal. In both scenario’s there will be processes adopted and whether it’s eating more healthily and exercising more, or automating parts of the collection and allocation process and enabling customers to self-serve for items such as copy invoices, once the target is achieved both will be stronger, healthier and more likely to achieve longevity.
Sure there will be bumps along the way, that takeaway that you know has a gazillion calories in it, but hey it’s the weekend, or that key client that despite best efforts and extended terms always seem to pay at 90 days rather than the 60 you’d agreed. But they pay, and the Sales Director doesn’t want their “biggest client” upsetting.
Nevertheless, reducing your DSO will significantly improve the profitability of your business and below are just a few pointers on the measures you could take to achieve your goal:
- Automate processes and offer customers the opportunity to obtain copy documents on a self-serve basis
- Credit check your customers before they open a trade account and periodically
- Introduce Direct Debit
- Don’t wait to invoice customers, instead invoice customers as soon as the product or service has been delivered.
- Make sure that you include Purchase Order Numbers where applicable.
- Set up an invoice template that includes all of the important information, including bank details, payment terms, due date and of course a clear description of the goods or services provided.
- Use an accounting system that alerts and reminds you of the accounts which are overdue.
- Offer customers the opportunity to pay their invoices outside of working hours (click here for more details)
- Ask for deposits upfront and part payments during the course of the project rather than invoicing the full amount following completion.
- Review your customers and reduce payment terms for those customers that repeatedly pay late.
- Charge late payment fees in line with the Late Payment of Commercial Debts Act to deter customers from paying late in the future.