Many analysts report that poor cash flow management is the number one reason businesses fail. Therefore, analysis and having the best tools at your fingertips is essential to safeguarding your business against bankruptcy, and one of the most critical analyses is “Days Sales Outstanding” or DSO.
DSO is a crucial metric to interpret and manage the cash flow of your business. This article will cover the importance of DSO, how to calculate this, perform analysis, and ways to improve this key number.
Importance of DSO
Days sales outstanding (DSO), also referred to as average collection period (ACP), is how many days it takes to collect money owed to your firm. We want DSO to be as low as possible from a cash flow perspective. If days sales outstanding goes down, then cash flow goes up and vice versa.
Collecting revenue later than necessary puts you in a vulnerable position; the organization may need to borrow money or sell assets to cover the cash-flow deficit. If there is a structural problem with collecting these receivables, a company can even experience bankruptcy.
Before we move to the calculation, here are a few relevant terms:
- Cash sale: A sale settled immediately. The payment can be made by a card, actual cash, or check.
- Credit sale: These are purchases made that do not require payment in full at the time of purchase. Payment can be later or over a period of time. For companies that use invoices, NET30, NET60, NET90 refer to payment done in 30, 60, or 90 days.
- Accounts receivable (A/R): The accounting term for all outstanding invoices owed to your company.
Days sales outstanding can be calculated by dividing the total accounts receivable by the total net credit sales during a certain time frame. This number is multiplied by the number of days in the period of time.
The time used to measure days sales outstanding can be monthly, quarterly, or annually. If you calculate monthly, the measured period will be the number of days in that month, likewise for quarterly or yearly.
You can find the accounts receivable total on the asset side of the balance sheet and the revenue in the income statement.
Now that you have determined your days sales outstanding, how do you interpret this data?
A frequent place to start is to figure out if invoices are past due, and this information should be within the terms in a customer contract. Language such as “net amount due in 30 days” is how to determine if invoices are not paid on time.
What are the reasons behind late payments? It is important to research potential issues like a shipment problem or late invoice delivery. If a firm is requiring their customers to pay by paper check, offering an electronic option could speed collections.
On the other hand, a low DSO is considered more favorable, and it shows that customers are paying on time or the company is strict on its credit policy. There is a possibility the organization is missing out on sales opportunities that would come from companies requiring more favorable credit terms.
Overall, having a low DSO for small to medium-sized businesses generally carries considerable benefits. Fast credit collectability decreases problems related to paying operational expenses, and a company has more cash on hand for other purposes.
It is beneficial to look at this measurement and its change over time. If this number increases, a business may need to tweak its accounts receivable or overall business processes.
It might be a good time to invest in accounting software that does online and automatic invoicing. These features can shorten the delay in payment. Additionally, software like FINSYNC’s complete solution can track payment status, send automated payment reminders, and customize invoices with payment terms included.
Another option would be to include more payment options like ACH and online payment alternatives to get paid faster. Additionally, it may be practical for online users to store their credit card information to streamline their payment process.
If customers are repeatedly late or unable to pay, it is time to question the effectiveness of the credit review process when enrolling new buyers. Get your sales team on board and determine potential red flags that can occur during the onboarding of new clients.
Across the board, DSO is an excellent metric for determining the efficiency and effectiveness of your organization’s collection process for outstanding payments.
Given the significant role of cash flow in an organization, having easy and regular access to your DSO values can help your business discover ways to collect outstanding bills as quickly as possible.
FINSYNC makes it easy to manage your cash flow, with intuitive tools that do the hard work for you. It’s just one more way that getting your finances in sync can help your business succeed.