Cash flow is the lifeblood of any business. To stay healthy and grow, you need cash constantly circulating through your company. A high DSO (Days Sales Outstanding) can slow that growth, even though there are countless strategies and courses to help improve cash flow. The bottom line remains: the quicker you collect payments for goods or services, the healthier your business and its cash flow will be.
However, while much effort is put into improving cash flow, less attention is often given to the true cost of a high DSO and how it negatively impacts profitability. In this blog, we’ll highlight the importance of maintaining a low DSO and share tips on reducing your DSO to benefit your business.
What is DSO and How Is It Calculated?
Days Sales Outstanding (DSO) is the average number of days it takes for your business to collect payment after a sale made on credit. A low DSO indicates faster payment collection, while a high DSO suggests customers are taking longer to pay.
Here’s a common formula for calculating DSO:
(Accounts Receivable ÷ Total Credit Sales) × Number of Days
For example, if your business made £500,000 in credit sales in April and has £350,000 in accounts receivable:
350,000 ÷ 500,000 = 0.7 × 30 days = 21 DSO
A DSO below 45 is typically considered low, though this varies depending on your industry and business structure.
How a High DSO Reduces Profits
Delayed payments come with clear disadvantages. As invoices age, the likelihood of non-payment increases, especially beyond 120 days, which can lead to lost revenue. Moreover, late payments cost you in other ways, such as overdraft fees and bank charges. These costs are often overlooked but could be avoided with better cash flow.
Businesses with a high DSO may struggle to cover monthly operational costs, leading to outside financing, which brings additional interest fees and further erodes profit.
There’s also the operational cost of chasing overdue payments. As debts age, invoices are more likely to be queried, which takes time and resources across multiple departments. If your business isn’t using an Online Payment System, manual copy document requests also consume valuable time that could otherwise be spent ensuring invoices are received and approved before their due date.
Using an Online Payment System to reduce customer queries can free up time for your team to focus on clearing overdue invoices, helping to lower DSO and operating costs while increasing profits.
How to Reduce Your DSO
Reducing DSO is like dieting: you set a target and take steps to achieve it. Whether you automate parts of the payment process or offer self-serve options for customers to access invoices, once you hit your goal, your business will be healthier and more resilient.
Here are some effective ways to reduce your DSO:
- Automate processes: Allow customers to obtain copy invoices or make payments on a self-serve basis via an Online Customer Portal.
- Credit check customers: Regularly evaluate customers before offering trade credit.
- Introduce Direct Debit: This ensures timely payments.
- Invoice promptly: Send invoices as soon as goods or services are delivered.
- Include purchase order numbers: This reduces delays caused by missing information.
- Optimise invoice templates: Ensure your invoice includes all necessary details—payment terms, due date, bank details, and a clear description of services.
- Use automated reminders: Set up an accounting system that alerts you when accounts are overdue.
- Offer 24/7 payment options: Make it easy for customers to pay outside of working hours.
- Request deposits and part payments: Secure funds throughout the project, not just at the end.
- Review payment terms: For customers that regularly pay late, consider reducing their payment terms.
- Charge late fees: Use the Late Payment of Commercial Debts Act to charge fees and deter late payments.