Written by Simon Beck, Senior Director, ANZ C2FO
Sufficient cash flow is critical to business success. Achieving key performance indicators is important if your business wants to meet the expectations of stakeholders, investors and colleagues.
However, presenting a strong, cash flow-intensive balance sheet can be difficult, especially if working capital is tied up in accounts receivable (AR). For small and medium-sized suppliers, customer payment terms are often extended, especially during times of economic uncertainty. If you’re waiting months for your bills to settle your accounts receivable, you’re likely depleting your working capital and potentially jeopardizing business continuity and growth.
Fortunately, there are ways to break long payment cycles and improve your company’s metrics quickly and easily. If your goal is to increase cash flow, one of the most important metrics to track is Days Sales Outstanding (DSO). What exactly is DSO and how can you improve (or lower) this metric?
What is daily sales outstanding?
Days Sales Outstanding is a measure of the number of days it takes Accounts Receivable to collect cash from outstanding invoices. In other words, DSO measures how long it takes customers to pay their invoices.
DSO goes hand in hand with the cash conversion cycle (CCC), a metric used to evaluate a company’s operational and management efficiency, which measures how long it takes to convert inventory investments into cash. The cash conversion cycle is calculated using the following formula:
CCC = DIO (Days Outstanding Inventory) + Days Sales Outstanding (DSO) – Days Outstanding Payment (DPO)
cash conversion cycle
where:
- DIO is the time it takes to sell inventory.
- DSO, as explained, is the time it takes to collect receivables.
- DPO is the time it takes to pay your bill without incurring a penalty.
A lower CCC indicates that you have healthy cash flow and sufficient working capital, while a higher CCC indicates that you may not have enough cash flow to operate and grow.
Maintaining a low DSO is important to keep the cash conversion cycle to a minimum. There is no magic DSO number to aim for, but you can evaluate the average DSO value among your competitors and other companies in your industry. Benchmarking your DSO against similar companies can help determine achievable value.
In 2020, many customers began extending payment terms with their suppliers to preserve cash flow amid the economic downturn. Some have extended to 90 to 120 days or more. Long payment terms continue to pose a challenge to today’s suppliers as rising inflation and other market factors force customers to hold onto working capital. If your business has longer payment terms, you may have a higher average DSO and consequently a longer cash conversion cycle.
Daily sales accrued equation
Days Outstanding measures the average collection time across customers. These are metrics that are typically tracked monthly, quarterly, or annually. To calculate DSO, divide your receivables by total sales for a period and then multiply this number by the number of days in that period.
DSO = (AR / Total Credit Sales) x Number of Days
Daily sales excellence equation
For example, let’s say Supplier A accumulated $100,000 in accounts receivable over 90 days and had sales of $250,000. Supplier A’s DSO is 36 because:
$100,000 / $250,000 = 0.4 x 90 days = 36 DSOs
Supplier A, with a DSO of 36 days, is close to the industry average DSO value of 37.3 for Q3 2022.
How to improve days outstanding
- Customer credit risk assessment
How thoroughly do you evaluate customer creditworthiness? A high DSO can signal customers who are late in paying. Conducting due diligence on new customers is a proactive way to prevent late or delinquent payments. Start by determining the level of credit risk your business is willing to accept. If you already have customers who pay their bills late, you can apply these criteria to them. Make sure your sales team is engaged to ensure new customers with poor credit history don’t suffer, or consider using trade credit insurance to mitigate risk without giving up new business.
- Manage AR closely
How does your company track outstanding invoices? As part of your collection strategy, establish a process for immediate follow-up. It is also important to investigate the cause of delinquency. For example, it may be possible to negotiate payment plans or early payment incentives for customers with cash flow issues. Setting clear terms for delinquency or non-payment can help prevent customers from missing deadlines and reduce DSO. Negotiate financial penalties for late payments and consider excluding customers who consistently pay beyond the agreed upon period.
- Send timely and accurate invoices
Customers are more likely to pay on time; Or even early, please send us the invoice as soon as possible. Invoicing software helps speed up the process by providing templates and automatic payment reminders to streamline invoice creation and follow-up. It can also help extend payment schedules and detect and correct errors that could result in DSO. Some companies strategically time their invoices, sending invoices during times when customers are more likely to open their emails and make payments, such as during the middle of the business day or during the week.
- Flexible payment options available
Four out of five U.S. businesses still use paper checks to pay their bills. To avoid delays caused by manual processes and paper-based systems, offer your customers the option to pay by card, automatically, and/or online. When customers can choose the payment method that is most convenient for them, they are more likely to get paid faster, increasing cash flow and lowering DSO.
- Strategically negotiate payment terms
If you have a large client base, you may be tempted to accept their preferred payment schedule because you don’t want to harm the relationship by negotiating a shorter term. However, neither party will benefit if the extended period depletes working capital. Insufficient cash flow may prevent us from fully delivering our goods or services on time, which may jeopardize our financial stability or cause supply chain disruptions.
The first step is to evaluate your financial statements and determine how flexible you want to be with your payment terms. try to do negotiate terms It suits our customers without putting their cash flow at risk. Early payment incentives can also be leveraged to reduce time-consuming DSOs, especially if the customer has strict terms.
- Early payment incentives provided
Early payment incentives are a cost-effective way to reduce DSO while strengthening customer relationships. Simply put, these incentives give customers a small discount in exchange for paying early. Many of our largest customers are already participating in early payment programs, allowing you to see savings on your DSO right away. Here’s how C2FO’s early payment program works:
- Participating customers upload approved supplier invoices to C2FO’s online platform.
- Suppliers log in to review outstanding invoices, select invoices to accelerate, and set their desired discount rate.
- If a discount offer is accepted, the Customer will advance payment to the Supplier, excluding the cost of the discount.
Unlike traditional early payment approaches, this model allows suppliers to choose when to request early payment and at what cost. This helps you control your DSO and increase cash flow. Typically available at a much lower cost than other working capital solutions such as leverage, lines of credit, or loans. Invoice Factoring.
conclusion
Daily sales are an important metric for assessing cash flow and ensuring you have the working capital you need to run your business, meet customer needs, and grow. Many small and medium-sized suppliers struggle to maintain their DSO at a reasonable level. This is especially true when customers extend their payment terms to increase their profits. The good news is that you can shorten your DSO using simple strategies, from assessing customer risk to offering flexible payment options. If you need to get your DSO under control right now, it might be a good idea to start an early payment incentive.
Click here To learn more about our early payment program — or Check if your customers are already using C2FO. You can request early payment today.