Day sales outstanding (DSO) is the average number of days it takes to convert credit sales to cash. In other words, it is the average number of days taken by a company to collect its receivables after a sale. DSO is one of the key metrics used by experts to measure the financial health and performance of a company.
The formula to calculate DSO is :
A company ABC makes around $20,000 credit sales and $10,000 accounts receivables in 40 days. Now, let’s calculate its DSO.
It means that company ABC recovers its dues in 20 days.
High DSO suggests that the company takes a lot of time to collect its dues. It indicates the lack of an efficient collection and credit analysis process. A business with high DSO often fails to convert the receivables into cash and in some cases, it may even have to write it off bad debt.
Let’s look into some strategies to optimize DSO.
You can effectively reduce DSO by providing customers with convenient payment options. For example, a self-service customer portal where customers can pay via their preferred payment options (such as credit card payments, ACH payments) helps reduce DSO. It also helps customers keep track of all invoices, pay multiple invoices at once, and raise disputes.
By offering discounts you can incentivize customers to pay early, hence reducing DSO. Additionally, some late fees can also be applied if a client fails to pay past the due date.
For SMBs, it is very crucial to track risky customers. By periodically evaluating customer worthiness you can update credit limits based on their risk levels. You can prioritize collections for risky customers to avoid bad debt and maintain a healthy cash flow.
High-risk clients are accounts that require immediate follow-ups as any negligence might result in bad debt. It is very important to identify high-risk accounts and open communications requesting payments before it is too late.
Tracking key high-risk accounts is crucial to measuring the operational efficiency of a company. By segmenting the customers based on various factors such as DSO, credit limit, aging buckets, or past payment history trends, we can create worklists that will help identify priority accounts for dunning and cash collections. All these efforts will eventually help reduce the risk of bad debt.
Let’s look at some effective strategies for customer segmentation.
By prioritizing customers based on aging, i.e. the time period for which payments are due, businesses can identify accounts that are overdue for a long time and make strategies to collect them as early as possible.
Customers can be segmented based on their payment history. This will help bucket on-time payers and late payers separately.
This will help segment customers based on their order value. You can then identify the large paying customers from others.
The beginning AR of an organization is $8000, and the credit sales are $16,000. The ending AR is $6200, and the ending current AR is $4000. Therefore, the CEI for three months would be 81%.
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