Cash flow is the core of any organization. A critical metric to monitor cash flow is Days Sales Outstanding (DSO). DSO is a measure of days taken for accounts receivable to be converted to cash. The sooner the business receives that money, the more robust its cash flow and financial standing is going to be.
If the flow is consistent, then the organization’s financial state will be strong. It can pay workers’ wages, undertake internal maintenance activities, and think about future growth. But if it’s the other way round, it will not be long enough before the company goes bankrupt. And such situations have happened for real. Industries driven by profits, like airlines and BFSI sector, are at a greater risk of increasing DSO.
Years of low interest and easy loans have allowed organizations to take their focus off managing DSO. If the organization can borrow money effortlessly at affordable interest rates, there is considerably less need to worry about DSO increasing by a few extra days.
Many organizations have sizeable opportunities to improve their DSO. The 2016 Hackett Group Working Capital Survey (registration required) of 1,000 public organizations exhibits how variable DSO can be from organization to organization. The study found a substantial difference between companies with average performance on DSO (43.5 days) and those in the leading 25% of DSO performers (25.1 days).
Practices for Reducing DSO
Minimizing DSO is not totally within the hold of finance and accounting. Various other parts of the organization also have an influence on this metric. Lowering DSO requires not only a concentrated effort from finance executives, but also the assistance of various business functions within the company. The following are strategies to bring down DSO.
Any attempt to reduce DSO will start with information on a company’s present DSO position and a benchmarking study that demonstrates how that measure of DSO stacks up with peers and competing organizations. This knowledge not only kicks off the effort but also presents a good sense of what DSO result is achievable for the company. The Hackett study offers some fundamental information by industry, but other industry studies or exclusive benchmarking surveys may provide more relevant information.
Accounting and finance professionals can use this information to create a scenario for reducing DSO to senior management and the various business functions whose help is essential. By making DSO reductions a top priority, executives can justify the required resources and include DSO betterment metrics into the individual performance goals and rewards of those driving the work. Businesses should focus on DSO reductions that are achievable and lasting for the organization.
Focus on Customer Credit
DSO is often influenced by the customer’s capacity to pay their debt on time. Hence, any attempt to reduce DSO must address customer credit risk and concentrate on suitable parameters for appropriate customer credit risks. An organization can then utilize these standards to ensure that new customers don’t have the characteristics of slow payers.. Companies can also extend the standards to existing customers, starting with those that have not been paying on time.
The sales departments in the company must buy in to this focus on customer credit risk. Sales staff never want to lose a sale because a customer has a history of credit challenges. Hence, organizations may need to apply specific rewards and penalties to ensure sales personnel and managers follow the organization’s credit parameters. Sometimes, companies can use tools like credit insurance to help offset credit challenges without sacrificing a potentially good customer.
Define Customer Repayment Conditions
DSO metrics are greatly influenced by the payment conditions an organization extends to its customers. Those conditions must thoroughly sync with the organization’s DSO objectives against prevalent market practice and customer needs and goals. This means determining under which conditions the organization will offer customer incentives for quicker payment or upfront payments, backed by a transparent approval process when making these choices.
Invoices should clearly mention payment conditions to decrease the possibility of misunderstanding over when payment is anticipated. The organization should regularly inform the customers regarding outstanding invoices and the ease with which customers could make payments. Some customers should be moved to an efficient, reliable electronic payment plan if possible.
Examine Invoicing Procedures
Inefficient accounting procedures can also impact DSO. Hence, reducing DSO frequently calls for attention to ensuring invoices go out on time, include all essential information, and are error free. A detailed review of the invoicing process, a spot check on invoices, can reveal errors that could impact a payment. Incorrect charges, invoices which do not indicate agreed-upon discounts, or the wrong postal address are just a few examples of common errors that can delay payments.
Organizations should frequently review and revise policies on when to send out invoices (Based on the date of signing the contract or at the time of delivery or setting some other milestone) and ensure that those guidelines are being followed. Invoice procedures should be audited to detect errors and policy non-compliance.
Manage Accounts Receivable Cautiously
Once invoices have been issued, an organization must have a plan for follow up on outstanding amounts and send out reminders to customers with past due balances. This interaction should concentrate on determining issues that are keeping the customer from paying the invoice on time. In some instances, a special payment plan could be arranged for a customer with a cash flow problem.
If non-payment persists, the organization should have in place a clear procedure for managing these situations and any conflicts that could occur. These procedures should include escalation procedures if required. For example, these rules could pertain to turning over unpaid invoices to a collection agency.
Maintain the Strength
Organizations must commit to lowering DSO and preserving the progress over the long term. Lowering DSO often demands for a change in practices as well as management techniques. Companies will need to ensure these process changes are permanent, and that people do not revert to the old methods. By conducting regular assessments of and interactions about DSO metrics, organizations can concentrate on these efforts.
Lowering DSO is a fairly simple way to fortify your organization’s cash flow. All it takes is a concentrated and continual effort. When your colleagues recognize the effect lower DSO can have, they are bound to provide the required support. So get going on lowering DSO now.