7 Strategies to Reduce DSO and Enhance Cash Flow

When accounting departments want a quick evaluation of the health of a business, they often look at their  DSO, or days sales outstanding. Traditionally, a low DSO indicates that your company has capital available and is in good financial standing. However, days sales outstanding are subject to a range of factors and targets should always be based on the wider context of the business and industry.

Understanding Days Sales Outstanding

Days Sales Outstanding, or DSO, is the average number of days it takes a company to collect revenue from an invoice. This includes both current, past and overdue invoices. Accounting operations managers use DSO to calculate the general ability of a company to collect invoices on time for a specific period (e.g. monthly, quarterly or annually).

Typically, a high DSO indicates that a company is having challenges collecting on invoices from its customers. In this case, eliminating bottlenecks in your collection efforts can be a quick and efficient way of improving your DSO for SaaS companies and other types of businesses. While it may be a rather one-dimensional measurement of the financial health of a business, it is still widely recognized as one of the best methods for a business to measure the efficiency of its cash management process.

DSO Formula

The formula for DSO is:

(Outstanding Receivables / Total Sales) x Number of Days = DSO

For example, a shoe manufacturing company would like to calculate its DSO for the quarter. It has $1 million in outstanding receivables but total sales of $1.5 million.

1,000,000/ 1,500,000  x 90 = 60 days sales outstanding (DSO)

This means that for this shoe manufacturing company, it takes an average of 60 days for it to collect invoices from its customers.

The Limitations of Traditional DSO

While it’s typically best practice to keep  DSO under 45 days, it’s not always as straightforward as it seems. DSO is influenced by a range of factors, such as the industry of the business, its competition, the geographic regions involved, and even seasonal fluctuations. For example, the global average DSO in 2020 was 66 days, but many industries were higher (e.g. manufacturing at 92 days and construction at 82 days) and others, such as retail, were lower (26 days).

Instead of managers focusing solely on days sales outstanding, it should be taken into account with other metrics related to the accounts receivable process. A high DSO and overly flexible credit options may indicate room for improvement in your A/R process, while a low DSO and overly strict credit options may mean you are missing out on business opportunities. Businesses may also see an increase in their DSO when they offer a new product line in another country, a risk they may be willing to take to facilitate long-term growth.

Despite the limitations of DSO, it remains one of the industry standards and is a critical element of the cash conversion cycle.

Best Possible DSO

An alternative but similar metric for businesses to consider in evaluating the efficiency of their cash management process is Best Possible DSO. Unlike traditional DSO, Best Possible DSO eliminates the fluctuation of past due receivables and is more performance oriented. As a result, it represents an ideal DSO metric for companies to aspire towards, although it is not always realistic. Companies who are able to get their traditional DSO within 3-4 days of the Best Possible DSO on average, however, benefit from healthy cash flows, long-term business growth and higher valuations.

Best Possible DSO Formula

The formula for Best Possible DSO is:

(Current Receivables x Number of Days in Period) ÷ Credit Sales for Period

7 Strategies to Reduce DSO

Since DSO reduction is such an important element of your accounting operations, many companies turn to tools such as DSO reduction software to assist them. Fortunately, there are simple ways to reduce DSO your business that assist you in improving your entire A/R process as well.

1. Automate the collections process. Automation streamlines the collections process, reducing human error such as unpaid invoices falling through the cracks. It can also include creating automated workflows that segment customers according to industry, geography, payment terms, and customer risk.
2. Simplify the payment process. Make paying as easy as possible by giving customers many payment options, including credit or debit cards, digital payments, check, bank transfers, etc. Self service customer payment portals also offer another convenient payment channel that minimizes errors, encourages timely payments and improves overall customer satisfaction. With a self service payer or customer portal, customers also don’t need sensitive information such as your bank account details. They won’t make a mistake and you can change your bank details easily, without worry.
3. Communicate effectively when sending invoices. Include payment terms,and all open invoices, including ones that are not due yet in dunning emails  to clients. The majority of the time, late payment is unintentional. Customers just need a reminder and clear directions on what they need to do to pay their invoices.
4. Consider other A/R data. DSO isn’t the only metric that evaluates the financial health of your business. Include a variety of A/R metrics in your business performance evaluation to gain a more holistic understanding of your business health and performance. This may include both individual and team collections performance KPIs, aging reports, collection effectiveness index (CEI), along with receivables turnover and best possible DSO.

Have an effective process in place to deal with late receivables. Document a process for how the company will deal with outstanding invoices. With the right software you can automate this process. Although you’ll want to primarily defend against delinquencies through escalation to relevant parties, you’ll also need to decide when your A/R will approach a collections agency, consider legal action, or write off the debt completely. Documented internal escalation procedures should also include which levels of management and heads of departments (e.g. Sales) will be notified as well and when you reach out to the customer and where you reach out to the payer’s boss.

Take a proactive approach. Many late payments can be avoided by simply reminding customers about invoices before they are due. This gives them time to react before getting an overdue notice. Offering discounts or other rewards for early payments and ensuring that communication with the customer is as clear as possible are also an effective way to encourage customers to pay their invoices before they become overdue. Use a credit monitoring tool to example customers’ past payment history and require stricter payment terms and implement tighter escalation processes for customers who present a higher credit risk.

Customize the payment terms for each client. Carefully assess the payment history of the company and the risk it poses to your business. Companies who have a history of better credit can be trusted more to make timely payments. For newer customers, you might consider starting with a small credit limit and  gradually increasing their credit limit.

How to Gavit Helps You Optimize DSO

Gaviti’s invoice-to-cash A/R management platform automates and streamlines the entire account receivables process, enabling businesses to improve DSO by up to 30%.

The modules include:

• Credit management and monitoring. Integrate with external credit rating agencies and other reputable sources to gain better understanding of the creditworthiness of your customers and prospective customers. Use online credit applications to streamline the credit approval process.
• Collections analytics. Track and measure A/R data, including both standard metrics such as DSO, collections rate and customer risk as well as smart KPIs such as individual and team collections performance, best possible DSO and total A/R.
• Customer self-service payer portal. Offer a full range of payment options including electronic wallets, bank transfers, credit and debit cards and integration into secure payment gateways such as Stripe and Bluesnap.
• Disputes and deductions.  Code, categorize and classify disputes to understand the different types of deductions and which recur regularly so that you can take actions to resolve them faster in the future and reduce the need for deductions.
• Cash application. Eliminate the need for manual matching of payments to invoices, accelerating the payments process and increasing your cash flow by improving DSO. With the use of the payment gateway, this matching achieves 100% accuracy, saving time and reducing errors.
• Invoice distribution. Automate the distribution of your invoices through a multitude of channels. Schedule invoice delivery at specific intervals or trigger them according to predefined events, such as order fulfillment or project completion.

Want to learn more about how Gavit can help improve DSO while automating and streamlining the entire A/R process? Speak to a Specialist! 

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