In the current volatile economy, Cash is the undisputed king! And maintaining a steady cash flow has become one of the top priorities of CFOs across the globe.
Mid-sized businesses often rely on cash for operational needs, driving revenue growth via sales, and attracting investment opportunities. And Days Sales Outstanding (DSO) could be a key metric to track cash inflow in order to fund and channel multiple initiatives. It refers to the average number of days for a business to collect payment from a credit sale, providing an overview of how fast your cash conversion cycle is.
While keeping track of accounts receivable through leading indicators such as DSO is a good starting point for businesses focusing on improving their working capital and cash flow – tracking only gets the job half-done! The second more critical part is to be able to understand and analyze DSO and fine-tune A/R strategies to reduce past-due receivables, cut-down on bad-debt, and enhance cash inflow.
In most cases, companies tend to misinterpret DSO, which leads to a wrong measurement of the company’s performance. In the pursuit of making the right decisions to grow business, medium-sized companies need to be very careful while interpreting DSO correctly.
DSO 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, especially in medium-sized businesses, 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 the right place.
As we know, DSO is also 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.
Medium-sized companies have an enormous appetite for growth, but may not always have the efficiency to compete with fierce global competitions. Most businesses fail because they are unable to manage cash flow. One of the main reasons businesses run out of cash is that they don’t get paid by their customers on time. Without enough money to fuel business operations, most companies tend to collapse.
However, having a great collection process should not come down to luck. Proper analysis of DSO could provide companies with visibility into how they are performing when it comes to the collection of payment from customers. Often DSO analysis and interpretation need a lot of research around the credit terms and payment trends. Few tactics to keep in mind while assessing DSO reports are –
To gain more insights, 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 appropriately.
Billing & invoicing should be regularly tracked to ensure minimal errors and faster invoice delivery.
Customer credit risk evaluation is essential 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.
To conclude, the solution for overcoming cash flow problems faced by mid-sized businesses is to measure and improve collection processes continuously. This ready-to-use templates for DSO calculation could provide businesses with insights about the Best Possible Day Sales Outstanding based on industry-level benchmarking. Overcoming business challenges requires strategy and planning, which is why mid-sized businesses need to understand the importance of financial metrics and their role in improving businesses leading them to success.
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