Formula to Reduce DSO
23 Dec 2021 | 03.08 AM

Need Cash Sooner? 5 Ways to Reduce Your Days Sales Outstanding (DSO) and Have A Reliable Cash Flow

At the core of high-performing companies is a tightened focus on financial health. The ability to forecast cash flow is crucial for taking advantage of opportunities, advancing revenue growth, and developing resilience—a valuable trait in this uncertain economy.

Research shows that organizations with a healthy cash flow excel in three areas:

  • scheduling and planning new investments
  • rapidly adding new products and services
  • managing emergency expenses

Does this sound enticing for your business? First, you need smart cash-flow management, which requires a laser focus on key drivers of cash: accounts receivable (A/R), accounts payable (A/P), capital expenditures, and debt services.

According to the Dun & Bradstreet Q3 2021 benchmark of A/R performance, 26 industry segments report that at least 10 percent of their aging dollars are past due by more than 90 days. This is a cause for concern for business buoyancy. After a year of slowness, as industries get back on the cycle of growth, staying on top of company collections becomes imperative.
One of the key indicators of your company’s cash-flow status is the Days Sales Outstanding (DSO) metric, calculated by dividing the total accounts receivable by the total credit sales, then multiplying that result by the number of days in the period you are measuring.

“In a typical business cycle, growth consumes cash, making it critical to understand DSO,” says Forbes Council member Jennifer Eubanks. “Not understanding this metric has landed many entrepreneurs in a cash-strapped position, stifling growth.”

An average DSO is 53 days, according to Celonis’s 2021 State of Business Execution Benchmark Report, based on an independent survey of 2,000 business leaders across six countries and eight industries. The top-performing companies surveyed achieve a DSO of 24.1 days.

So how can your organization improve its DSO? Here are some suggestions:

1. Set realistic expectations

Knowing your DSO status inside and out is essential. Perform a benchmarking analysis that shows how your organization’s DSO compares with your competitors as a first step toward setting your DSO key performance indicators (KPIs), Information from industry resources and credit reporting companies can help to select the right benchmark.

Another benchmark to be considered is your company’s terms of sale. If your DSO results vary by wide margins from your terms, it can be an indicator of poor collections or non-competitive sales terms.

2. Deal with unpaid invoices

According to the Celonis benchmarks report referenced earlier, on-time payment of suppliers happens only 50 percent of the time. In an uncertain business climate with frequent economic downturns, it is likely that this is due to the challenges companies face in closing their own invoices on time.

A way out of this conundrum is to adopt a proactive approach to collections that demands better use of data. This entails getting rid of inefficient processes and unifying fragmented data sources. Doing so can alter the ways A/R teams prioritize payments and mitigate the chances of delayed payments.

Relevant data analysis provides meaningful insights to identify the invoices which have a great impact on KPIs. For instance, the optimized utilization of process mining helps in identifying and eliminating execution gaps, equipping A/R teams to prioritize invoices based on outcomes.

3. Streamline invoice management

Updating your invoicing process from paper to digital is a surefire way to improve your DSO. Paper invoicing is manually intensive—it requires preparing and printing an invoice, sending a physical copy to the customer, then waiting for the customer to send you a payment, along with mailing delays and risks. This method also delays customer feedback on invoices that require formatting revision or line-item correction, many times stalling the A/R process completely due to a customer’s lack of response for an incorrect document. 

Digitizing invoices improves data accuracy and reporting while speeding up your company’s ability to send and receive documents. This significantly reduces DSO as customers are likely to pay faster for accurate and complete invoices received in the right format.

Case in point, Hewlett Packard Enterprise was able to reduce its DSO from seven or more days to two hours by using digital invoicing. This reduced invoice errors and condensed the turnaround time, providing the company better insight into clearance of invoices. With the e-invoicing market projected to grow 22.1 percent annually from 2021-2026, digitizing invoices is a must for reducing transaction time and lowering DSO.

4. Perform credit evaluations

For companies continuing to recover from 2020—or even for those who are prioritizing resilience in our volatile economy—budgets are tight. For A/R teams, this means mitigating financial risk. Determining customer creditworthiness before extending credit is an important consideration to ensure timely payments.

Know your customer's credit scores and understand their cash flow situation (review their cash-flow statements and debt-to-income ratio) before offering them payment options. This is a part of an effective credit analysis and will clarify the customer’s ability to pay for goods and services.

5. Define payment terms

A company’s A/R typically consists of multiple invoices with varying payment terms. If these payment terms are not closely aligned to DSO goals, it can impact collections. It is, therefore, important for companies to clearly define when they expect to be paid in their contractual agreements. For example, consider adding the invoice due dates and preferred payment method and currency.

It is also necessary to define when the company will provide discounts for faster payments or charge for overdue payments. Once the payment terms are agreed upon, A/R teams can do continuous follow-ups for prompt payments while maintaining healthy relationships with your customers.

The DSO metric matters

Research shows that if companies can step up on their DSO reduction efforts, the reward will be a strengthened stream of cash flow. With uncertainty becoming the new certainty, it an imperative for entrepreneurial organizations to set attainable and sustainable goals for DSO.

Breaking organizational silos and having the right systems, technologies, and process efficiencies in place naturally improves collection effectiveness.

Regular reviews of DSO metrics can help keep the focus on what KPIs matter most and reduce DSO sustainably.

How AG can help

Accelerated Growth has worked with hundreds of entrepreneurial organizations in growth mode to build sound financial foundations. Let us review your A/R processes to understand your challenges and provide solutions that support your cash collections, empowering your business with the resilience it needs in today’s market.


Other Blogs