Skilled Chief Financial Officers (CFOs) know that Days Sales Outstanding (DSO) is a key measure of a finance team’s efficiency and is closely linked to days cash on hand and liquidity.
Every organization is happy to have sales, but closing sales isn’t enough to keep a business afloat. Collections from outstanding invoices are key — and the faster the payments come in, the more financial breathing room an organization has.
The fastest collectors get paid in 30 days or less on average. The businesses that are slower to collect take 48 days or longer to receive payment on their invoices, on average. At the median, across all industries, companies need about 36 days to close the AR cycle.
However, it is very important to keep in mind that a “good DSO” number in one industry may be a disaster in another.
Take the healthcare industry for example, payment is often subject to reimbursement by insurance companies, so 40 days or less would usually be considered an excellent DSO. In manufacturing, a DSO of less than 30 days is more often the norm.
The best way to know how your DSO stacks up to others in your industry is to benchmark DSO against your peer organizations. A good CFO is crucial in understanding how to benchmark DSO and how to drive improvement in the overall process.
Cash is the life blood for any organization, it’s what fuels the company’s very existence. DSO is like the oxygen, you need to fill it with more than you’ll use up in a given time period, or your company’s bottom line will drown.
When sales are going great, it’s easy to become overconfident and spend money the organization hasn’t yet collected. If it takes too long to collect, you could deplete your reserve too soon and find yourself desperate for cash.
Ideally, businesses would collect payment faster than needed to pay their payables. But realistically speaking, that is far from the usual situation.
One effective way to collect payment is to have a dedicated team contacting customers and reminding them to pay their outstanding invoices.
However, many small businesses don’t have the budget for a full-time credit and collections department. Working open invoices tends to fall on whichever finance team member can fit in the extra time. Making collections a day-to-day job keeps the pressure on customers to pay late bills, which significantly increases cash flow.
Another important factor to consider is whether the organization is collecting on its customer’s terms, or on its own terms. Is it giving customers 60 days to pay, while competitors insist on net 30? If so, does giving extra time encourage customers to buy more, and is it worth taking a hit to working capital to float some customers credit for an extra month?
For high-volume, dependable customers, the answer may be yes. For key strategic partners, an organization may be able to work out an automated payment system that seamlessly facilitates movement of product or services and cash back and forth, without paperwork delays.
For fixed-fee service work, establishing a payment schedule based on estimates can help both sides better predict and control cash flow.
It’s also extremely wise to break down and address the various reasons that customers pay late.
Delays are not always due to a customer not having the cash on hand. Are there quality issues with a product or service that are in dispute? Is paperwork missing or incomplete? Has the customer switched to new supply chain management software that requires additional detail that the seller’s invoices don’t have? Is it possible that the customer is using any or all of these factors to delay payment and keep that cash in hand a little longer?
A little digging may reveal that payment for services is being held up by missing receipts or errors related to expense reimbursement. A simple fix is to send two separate invoices: One for expenses and another for time and materials.
That way, the customer won’t have any reason not to pay for services, even if the expense issues take a little extra time to resolve.
In a world where cash is essential, every day that cash is in someone else’s hands is a day that an organization could be breathing a little easier if it were in its own hands. Taking time to evaluate and improve collections processes can reduce DSO, and means more money in the bank and less time spent underwater.
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