How to reduce DSO and improve your cash flow
Discover five ways to reduce your Days Sales Outstanding (DSO) and improve your cash flow.
What is DSO?
Days Sales Outstanding (DSO) determines the average length of a company’s collection period. It is a key metric for tracking your credit control performance.
Most businesses that offer credit to their customers strive to keep their DSO as low as possible.
How to calculate DSO
DSO = (accounts receivables / total sales) * number of days
To calculate your DSO, divide the total number of accounts receivables during a given period by the total value of credit sales during the same period. Then multiply the result by the number of days in the period.
For example, last month Ann Example Ltd sold £100,000 worth of goods. It had £75,000 in accounts receivable on its balance sheet. Its DSO would be 75,000/100,000 * 31 = 23.25 days.
This means that on average it took Ann Example Ltd 23 days to collect payment after a sale.
Why is it important?
A healthy cash flow is essential for the success of any business.
Businesses with a high DSO may experience restricted cash flow which can limit their potential.
Reducing DSO, even slightly, can improve cash flow and allow businesses greater flexibility for growth.
Plus, tracking your DSO over time can be a great way to measure your credit performance and identify when improvements are necessary.
How to reduce DSO and improve your cash flow
There are numerous strategies to help reduce DSO and improve your cash flow. Here are just five:
1. Consider updating your payment terms
The payment terms that you offer to your customers heavily influence your DSO. Therefore, adjusting your payment terms could be the key to reducing your DSO.
It is important that your payment terms carefully balance protecting your cash flow and providing an attractive proposition to win and retain customers.
Once you have set your terms it is essential that you communicate these clearly to your customers. Failure to do so could cause payment delays.
Your terms should be set out in a contract signed by the customer before any products or services are supplied. This should be repeated on each invoice and complemented with an exact due date.
2. Reduce credit risk
Any effort to improve DSO must address customer credit risk. Are you offering credit to customers who can’t or won’t pay?
You should always assess the financial standing of new customers as best you can to reduce your credit risk. There are several ways to do this. For example, account opening forms, credit checks and online searches are all useful tools.
However, it’s not enough to just assess new customers. Especially in the current climate, a company’s financial status can change at any moment so regularly reassess the credit risk of existing customers too.
3. Improve invoicing processes
Did you know that slow and inefficient processes are a leading cause of late payment? Therefore, improving your invoicing procedure could be a quick way to reduce DSO.
To do this, ensure you have a solid system in place so that invoices are generated and distributed as soon as possible.
Plus, always ensure that your invoices are accurate as mistakes could lead to disputes or delays in payment.
This includes making sure the invoice is addressed to the most appropriate person at the correct address, as well as proofreading for grammar, spelling and mathematical mistakes.
Also, it is a good idea to call your customers to confirm that they have received the invoice. This reduces the likelihood of late payment excuses such as ‘I haven’t received the invoice’ and allows you to reconfirm the due date.
4. Stick to a clear credit control procedure
Unfortunately, it’s often not enough to just send an invoice and expect it to be paid on time.
Your credit control procedure should include a plan for following up on outstanding balances and reminding customers of unpaid invoices.
Keeping in regular contact with customers throughout the credit period gives you the opportunity to remind them of upcoming deadlines and discuss any potential issues before they impact your cash flow.
Plus, this communication helps to build stronger relationships which can encourage prompt payment and even future sales.
5. Act quickly on overdue invoices
Overdue invoices not only increase your DSO, they also threaten your business’s cash flow and financial security, so it’s vital to act quickly in order to protect your business.
If your internal efforts aren’t having the desired effect or are consuming too much time, consider outsourcing its recovery to a specialist debt collection agency.
Often, simply introducing a third party will encourage the customer to pay, and a debt collection agency will use all its expertise to recover payment quickly, typically on a success-only basis, whilst striving to protect your customer relationships.
This gives you back the time and resources to focus on the rest of your sales ledger.
Plus, once your customers know that you take any late payment seriously they will be less likely to try delaying payment again.