Improving cash flow is a top priority for businesses. Money is needed for day-to-day operations, payroll, business transactions, and loans. Mastering Days Sales Outstanding (DSO) can greatly improve your business finances and help your company thrive.
You may be asking yourself, “What is DSO?” Days sales outstanding (DSO) is the average number of days that receivables remain outstanding before they are collected. It is used to determine the effectiveness of a company's credit and collection efforts in extending credit to customers, as well as its ability to collect from them. It’s hard to continue funding your own company’s growth when you’re extending your customers so much credit in the form of net-terms, so measuring your DSO is critical.
How Can My Company Master Days Service Outstanding?
To calculate the DSO ratio, take your total accounts receivable and divide it by the average sales per day. For example, if your business’ accounts receivable is $2,000 and revenue is $25,000 for the past year, your DSO is 29 days (2,000/ (25,000/365)). Higher numbers mean that your business has longer collection periods. It is important to compare payment terms and average industry collection times in order to properly assess the DSO ratio and make changes accordingly.
Track and Improve
You can’t improve what you don’t track! It is critical to calculate and track these figures monthly in order to stay on top of cash flow and avoid money flowing out faster than it is coming in. If collection times are longer than average, you can be aware of it relative to previous months or quarters by tracking your DSO. Measuring your performance against the average is a great way to prove that you should (or shouldn’t) be spending more time following up with your customers that have outstanding invoices. In fact, we’ve found that the simplest way to improve your DSO is to send regular reminders to customers well before an invoice is overdue. Reminders coupled with expectation setting is a great way to ensure you get paid on time. "Can you review our most recent invoice to let me know if there are any discrepancies? If there are none, can you let me know when I can expect payment?”
Focus on Quality Clients
Determine your “ideal client” and be wary of red flags during your client intake process. Have a conversation regarding the payment process and terms upfront and take note of any part of the conversation that may indicate delays or difficulty in receiving timely payments. Also, keep track of your customer’s early, on-time, or late payments. Being aware of two late payments in a row after a long period of on-time payments give you the opportunity to have a discussion and nip the problem in the bud before you end up in a situation where those late payments turn into nonpayment.
Send Detailed Invoices
When sending invoices, make sure you reiterate the payment terms from your contract. Avoid ambiguous terms such as “net-30” or terms that may confuse those who aren’t familiar with business jargon. Being detailed about the due date anchors expectations solidly when payment is expected. Also, consider including an incentive with invoices, so clients pay you on time. For example, you could give a 5% discount for payment within 7 days after issuing an invoice.
Consider Omitting Net Terms on Invoices
I know this is counter to the last point, but if you’re serious about collecting ASAP consider eliminating any mention of the due date on your invoices. Sending an invoice and following up every week with something like: “I’m just making sure you received the invoice for $xxxxx, when can I expect payment” can result in very early invoice payments which will do wonders to drive down your DSO and improve your cash flow. Word to the wise: This doesn’t work with large company’s AP departments, for that you should consider invoice factoring (more on that below).
Request an Upfront Deposit
Requesting an upfront deposit is a way to get clients vested in the project from the start and demonstrates the client's commitment. It increases the likelihood that future payments will be made on time and will help you avoid having unpaid invoices.
Invoice Factoring to Increase Your Cash Flow
If you have invoices out to large company AP departments there’s not a lot, you can do to impact your DSO with them. They will usually pay regularly, but on their own terms of net 30, 60 or even 90 days. Finding a growth partner like Finance Fuel will result in you having the majority of the invoice’s value advanced to you on the day it’s sent. Once the invoice is paid you will receive the remainder minus Finance Fuel’s fees. The value of having your money 30, 60, or 90 days earlier is huge when you consider what growth projects you could take on in that time.
No matter which way you slice it, consistently measuring DSO will give you a snapshot into how long you’re financing your average customer’s deal. Taking one or more of the steps listed above to drive down DSO will limit the amount of credit you’re extending your customers and allow you to use that increased cash flow to fund other ongoing projects.