Cash is king and critical to your survival. In many cases, improving cash flow is as simple as making small changes to collections processes, but in the end, you'll likely need the know-how of a professional bookkeeper to keep you on target. In this article, we discuss tips for reducing the Days Sales Outstanding average as an important method for improving cash flow.
Days Sales Outstanding (DSO) is an important bookkeeping metric to monitor. DSO measures the average age of accounts receivable — if your average is trending higher, then your business is more likely to struggle with cash flow. Knowing your DSO can also help determine whether or not to outsource collections or to simply improve your current processes and policies.
What is DSO?
Defined, Days Sales Outstanding is: A measure of the average number of days that a company takes to collect revenue after a sale has been made” -Investopedia
The calculation is fairly straightforward:
Accounts Receivable / Total Credit Sales X Days in Period
Let's look at a simple monthly example scenario:
Your Company, Inc. started with $500 in receivables in January. Throughout the month another $400 in credit sales was made, putting the accounts receivables up to $900. Some invoices were paid as well, totaling $300 in payments received on credit sales. So at the end of January, the accounts receivables total is $600. If you want to calculate DSO for the month of January, here's how to plug in the numbers:
$600 (accounts receivable at the end of January) / $400 (credit sales in January) X 31 days = 47
Because a single month is usually not enough information, DSO needs to be calculated on a month-to-month (or period-to-period) basis to see if the trend is moving higher or lower.
The easiest way to reduce DSO is through lightning fast invoicing. The longer it takes for a customer to get an invoice, the longer it takes for them to get your cash.
For example, let's say your average time for billing is 17 days and your DSO average is 36 days. By automating your invoicing process through Intuit Merchant Services or other methods, you may be able to reduce this to three days, shaving two full weeks off of your DSO.
While billing your clients more quickly does not guarantee faster payment, many firms have a consistent payment process. Timely billing generally means timely payments.
Fast Payment Incentives
Have you ever worked with a client that continually made excuses for not having their payment to you on time? Whether they're being genuine or genuinely stalling, this still amounts to cash that is not in your hands. Fortunately, there are some tricks for encouraging clients to pay on time — or even early.
Keeping a credit card number on file is by far the easiest way to get your payments in on time, and this gives you the ability to charge their credit cards a week earlier, as an example. However, you probably have set up payment policies in your contract with a client. You will need to discuss with the customer before you start charging their cards a week earlier than usual. If you have problem clients, having a credit card on file can still help stabilize your DSO. A courtesy call is usually appropriate and gives you an opportunity to check on the quality of your products and services.
Using net 30 or net 60 terms for payments is a generally accepted practice with which most companies are familiar and a powerful technique for getting payments early. For example, some agreements contain a policy like "5% 15, net 30", which means the company gets a 5% discount if full payment is made within 15 days of receipt of goods/services and that full payment is required within 30 days. So, a discount is given for payments received early. You can even include penalties for late payments.
Fire Bad Customers
While it may be against every impulse, sometimes you just have to let bad customers go. If your average DSO is 36 days and you have low-paying customers with an average payment coming in 60 days after invoicing, you may need to consider cutting them loose.
The key to the decision to fire bad customers is a matter of costing, which your bookkeeper can help you determine. Every activity your firm engages in has a cost, and hopefully these activities average out to be more profitable than costly. Extra collections activities, second and third invoices, and the lost use of the cash when you need it, can be calculated to determine whether or not a customer is really worth keeping around.
Conclusion: A Knowledgeable Bookkeeper is Critical
The days sales outstanding is a critical measure for determining how much cash you can expect to have on hand. Longer DSOs mean that you spend money on activities or products and don't get paid for a longer period. Reducing DSO is a very important method for improving your cash flow.