Days Sales Outstanding(DSO) calculates the average number of days to collect a company’s receivables after a sale has been made. DSO is a popular metric across different industries. It reflects the health of an organization’s accounts receivables indirectly pointing out how the Credit and Collections teams are performing.
Various industries follow different approaches to calculate their DSO. Primarily, it is calculated using the following two methods:
Moreover, an organization could streamline its performance by tracking and calculating DSO at an account level or a regional level. For instance, credit professionals could track DSO separately for customers based out of US and UK and tweak credit policies based on geographical trends.
DSO is just a number. It is critical for credit and collections managers to understand and plan for the next action items based on it. The following use-cases would explain how senior management often fails to leverage DSO to improve their business processes.
From the graph, it is evident that the DSO of Colgate is 34.09 and the DSO of P&G is 25.15. Does this mean that Colgate has a scope of improvement in collecting its receivables? This might not be true because we are not aware of Colgate’s payment terms. If the payment term of Colgate is 30 days, then there is scope for improvement, while if the payment term is 60 days, then we could say that their Collections efforts are in right place.
As we know, DSO is highly influenced by Sales teams. The following two examples support this statement:
This is why before jumping to a conclusion, the Credit and Collections teams should have a knowledge transfer with Sales teams.
Imagine you are sending multiple payment reminders to your customers but they have not received the invoice at all. Also, they would not pay for an incorrect invoice. One fault of your Billing & Invoicing team could undermine the customer experience, along with an increase in DSO.
Companies need to do a customer-wise analysis of invoice acknowledgment. This would help them understand whether the customers have received their invoices on time or not. DSO evaluation should be dissected based on faulty invoices, late invoices to have more insights. To have better tracking of billing & invoicing, organizations should resort to EIPP.
A wrong approach to judge DSO could lead to the setting of unrealistic targets by senior management. For example, while undertaking digital automation projects, you might end up setting wrong DSO targets in the ROI calculation. This would result in an improper action plan which might be counter-productive for the organization’s A/R operations.
Often DSO analysis and interpretation need a lot of research around the circumstances which led to the DSO. The following parameters should be kept in mind while evaluating DSO reports:
To gain more insights on this, read this ebook on how to reduce DSO by 15%.
A win-win strategy is necessary to scale up DSO which would in-turn impact the bottom-line of your organization. Some best practices to improve DSO are:
Payment terms should be customer-specific and should be tracked properly.
Billing & invoicing should be regularly tracked to ensure minimal errors and faster invoice delivery.
Customer credit risk evaluation is important to make sure that the Credit & Collections teams are not onboarding high-risk customers with lenient credit policy.
Credit and Collections teams should properly prioritize, prepare call scripts, perform aging analysis before calling up a customer.
DSO as a metric leaves room for assumptions. So, it is better to analyze DSO collectively with a few other metrics. This would help the senior management to get a clearer picture of what the bottlenecks are, and what the next action item should be.
To analyze the performance of the Order-to-Cash teams, CEI is perhaps the best metric to consider along with DSO. CEI helps the senior management to understand how effectively their Collections team is performing. To know more about CEI, read our next blog.
Bad debt to Sales directly shows how much amount had to be written off as the customers were unable to pay their dues. This KPI is calculated as a ratio, and if the ratio tends to increase with time, then it reflects ineffective credit policies and management.
DDO is calculated and considered to get an idea of how the organization is dealing with its Deductions. It is calculated by dividing the outstanding deductions to the average deductions which were faced during the last three/six/twelve months.
A/R turnover ratio is a metric that specifies how efficiently an organization is collecting its assets. A higher A/R turnover ratio is recommended as it reflects a strict credit policy and effective collections of receivables.
BPDSO is a theoretically-calculated metric that specifies the best possible number of days in which an organization could collect its receivables. The motive behind calculating BPDSO is to initiate an internal comparison between the DSO and BPDSO so that the senior management can set the right approach to benchmarking.
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