Days sales outstanding, otherwise known as DSO, is an essential formula for measuring how efficient a company is at retrieving outstanding payments. If you’re generating healthy sales but it’s taking your company too long to see the fruits of its labour, your cash flow is going to dry up, fast.
The good news is that there are several strategies you can implement to optimise your debt collection processes and reduce your DSO.
In this guide, we’ve highlighted the importance of reducing your company’s DSO and included some of the most innovative solutions to help your company start securing what it’s owed more quickly and enable you to use the profits to accelerate growth.
How does your company’s DSO measure up?
Key takeaways:
- A high DSO can result in lack of cash flow, which stunts growth, wastes valuable resources and potentially damages customer relations.
- The average DSO is 64 days, while one in four companies are waiting 88 days or longer and 9% exceed 120 days. The fastest collectors will have a DSO of 30 days.
- Your ideal DSO should be determined by comparing it against industry benchmarks, factoring in economic fluctuations, and your company’s capital structure as well as size.
- The DSO calculation formula = (total accounts receivable / total credit sales) x number of days.
Why is reducing DSO important?
With every sale put on credit, there’s an outstanding balance, known as accounts receivable (AR), you need to collect. If you’re taking too long to settle these accounts (i.e. your DSO is too high), the subsequent lack of cash flow will stunt growth, waste further money on chasing payments and potentially damage customer relations in the process too.
What does a good DSO look like?
Generally speaking, the lower your company’s DSO, the better it is.
According to a Euler Hermes study, the average DSO across 20 sectors is 64 days, with one out of every four companies waiting 88 days or longer and 9% exceeding 120 days. Multiply this timeframe with hundreds or thousands of clients and your company will start to feel the pinch. In contrast, the fastest collectors usually get paid in 30 days or less.
Although it’s worth noting that a “good DSO” number in one industry might not be the same in another. For instance, receiving reimbursement from insurance companies within 40 days or less is generally seen as a positive in the healthcare industry. Whereas a DSO of less than 30 days is a common occurrence in the manufacturing industry.
To gain a better insight, you should compare your company’s DSO against industry benchmarks, plus factor in economic fluctuations and your company’s capital structure and size.
How to calculate DSO
The easiest way to work out your days sales outstanding is to use the total credit sales, accounts receivable and a set number of days to create the following DSO calculation formula.
For clarity, your total credit sales represent the sum of sales over your chosen period and the accounts receivable is only measured on the last day of the period. In other words, the accounts receivable represents the money outstanding from the total credit sales at a particular moment in time.
To put this into practice, let’s use a hypothetical example. During the 30 days of April, if your company made €100,000 in credit sales and only €25,000 is paid off at the end of that month, you’d have €75,000 in accounts receivable. Therefore, your DSO calculation would look like this:
€75,000 (total accounts receivable at that moment in time) / €100,000 (total credit sales) = 0.75 X 30 (number of days) = 22.5 days
It’s worth remembering that this DSO calculation method doesn’t account for cash sales, where zero-days are outstanding on a sale or service. If these were taken into account, the total DSO would be considerably less.
How to reduce your company’s DSO
If your DSOs are higher than they should be after benchmarking your performance with the rest of your industry, you need to address your strategy.
1. Stricter credit approval
The number of days outstanding is subject to your customers’ ability to pay their invoices on time. While sales are important, if your company isn’t carrying out the right credit evaluations in the first place, you’ll struggle further down the line.
One of the most common problems is in the sales function. Have your sales team been trained to carry out strict procedures to identify customers with credit problems? Do they have access to the right tools to run these tests?
If you feel like this is a major factor affecting your DSO, it may be worth introducing specific incentives and penalties to make sure your sales team sticks to your company’s customer credit requirements.
2. Update your payment terms
Take a look at your company’s current payment procedures. Could you offer customers early payment discounts for settling their invoices within 10 to 15 days? Are you offering flexibility by accepting credit cards?
We’re living in a digital world where people crave simplicity. Paper checks are outdated and demand a process.
Any payment terms need to be clearly and visibly stated to reduce the chances of confusion. Don’t make the mistake of putting them in the small print at the bottom of a contract or invoice. Your sales team should tell the customer the payment terms at the point of the credit sale to ensure you’re being transparent from the outset.
3. Automate manual processes
Getting employees to constantly spend time communicating with customers is wasting valuable money and resources. Manual, paper-based communications, such as writing and sending letters, are prone to human error and take days to arrive in the post. Then you have a natural delay in customers taking action, which can waste another couple of days.
Processing paper check payments is time-consuming too, while paper invoicing leaves a large paper trail. A decentralised system with never-ending manual, paper-based receivables is hard to trace and can easily be lost. In the buying cycle, companies can use several dealers and distributors along the way. Begging the question; how can you efficiently monitor all accounts receivable and accounts payable?
Automating can ease the bottleneck in the process and reduce your company’s DSO. This includes:
- Reminding customers – use pre-scripted texts, emails and social media messages.
- Simplifying the payment process – build responsive landing pages and offer instant payment solutions.
4. Be responsive, but forthright
These automated solutions should be a part of a wider plan for following up outstanding balances. Not every customer journey will be lineal, there will be some clients who suddenly fall behind on payments due to financial setbacks or a lack of business. Your automated responses must be adaptable to suit these needs, otherwise, you’ll end up wasting even more resources trying to fix the problem.
A lot of success in clearing outstanding payments is achieved by using the right tone in communications. Yes, you should be prepared to send multiple texts, emails and letters, but you don’t want to become so relentless that it undoes all customer relations.
Customer loyalty and repeat business is the driving force behind your company’s future success. There are a lot of negative connotations associated with debt collection. Using softer language and coming across as approachable is a good way to start the process or tackle sensitive situations. However, your messaging always needs to clearly state the terms.
Be willing to adapt the language you use to suit certain circumstances, but don’t compromise your authority in the process. Customers are much more likely to settle outstanding payments if your company is helpful and accessible, yet serious.
Final thoughts
At the end of the day, if you focus on your days sales outstanding and continue to work on your strategy, you’ll improve your cash flow. It’s a case of establishing a realistic DSO by comparing industry benchmarks and taking a proactive approach in finding solutions to potential problems that could cause a bottleneck in the process before they happen.
As a starting point, we highly recommend you download our free DSO calculator. This tool uses a DSO calculation formula to give you a clearer indication on current cash flow, accounts receivable and credit sales. You’ll gain a better grip on your DSO and will be able to monitor it all in one place for complete peace of mind and ease.
