Discover how to reduce DSO and improve cash flow. Explore the 4 key steps, from setting realistic expectations to investing in technology.
Ever felt like you're running a marathon with your business's cash flow, where the finish line keeps moving further away? That's the challenge of managing Days Sales Outstanding (DSO). In today’s debt-surmounting reality, knowing how to reduce DSO is akin to finding the perfect pace and getting first place in your company’s race to peak profitability.
In this article, we'll delve into 4 impactful strategies that will not only help you understand DSO but also master the art of reducing/improving it. From setting realistic expectations to leveraging technology, these steps are your business’s roadmap to a healthier, more robust financial future.
What is DSO (and why you should care)
DSO, or Days Sales Outstanding, is a financial metric that quantifies the average number of days a company takes to collect payment after a sale has been made. It's a key indicator of the effectiveness of a company's credit and collection efforts, as well as its cash flow management.
Calculating DSO is straightforward. You divide the total accounts receivable during a certain period by the total net credit sales for that same period, then multiply the result by the number of days in the period.
For example, if a company has $20,000 in accounts receivable during a 30-day month and $60,000 in net credit sales, the DSO would be (20,000/60,000) x 30, which equals 10 days. This means it takes the company an average of 10 days to collect payment after a sale.
Why should you care about DSO?
Well, a high DSO means it takes longer for a company to collect payments, which can lead to cash flow problems. It's like having your money stuck in traffic when you need it to be zooming down the freeway. On the other hand, a low DSO indicates that a company collects payments quickly, suggesting efficient credit and collection processes and healthier cash flow.
In essence, DSO is more than just a number. It's a pulse check on your company's financial health and a compass guiding your cash flow management strategies. Let’s see how you can go about reducing it.
Step 1: Setting Realistic Expectations
Embarking on the journey to reduce DSO begins with setting realistic expectations. It's like setting a destination on your GPS before you start driving. You need to know where you are now and where you want to go.
Understanding your current DSO status is crucial. It's about taking a hard look at your numbers and acknowledging your starting point. You can't map out a route to improvement without knowing your current position. This involves calculating your DSO, as explained in the previous section, and comparing it with previous periods to identify trends.
Once you've grasped your current DSO status, the next step is to set achievable improvement goals. This isn't about aiming for perfection overnight but setting targets that stretch your capabilities without breaking them. It's about progress, not perfection.
Benchmarking can be a valuable tool in setting realistic DSO targets. This involves comparing your DSO with industry averages or with companies of a similar size in your sector. Remember, though, that every company is unique, so these benchmarks should guide, not dictate, your targets.
Setting realistic expectations for DSO reduction is like planting a flag on a mountain peak. It gives you a clear goal to strive for and a measure of success when you reach it. And with each step forward, you're not just reducing DSO; you're building a healthier, more resilient business.
If you are interested in learning more about how to effectively set goals, take a look at the SMART methodology.
Step 2: Dealing with Unpaid Invoices
Step two on our journey to reduce DSO involves tackling one of the most common culprits of high DSO: unpaid invoices. It's like clearing the roadblocks on your path to improved cash flow.
Proactive collections management is key here. This means not waiting until an invoice is overdue to start the collections process. Instead, it involves regular follow-ups with customers, starting from the moment the invoice is issued. This can be as simple as sending a friendly reminder a few days before the payment is due.
Prioritizing payments is another effective strategy. Not all unpaid invoices are created equal. Some may represent a larger amount or come from a customer who is habitually late in making payments. By prioritizing these invoices, you can focus your collections efforts based on high-value opportunities.
Acting on late payments is also crucial when managing unpaid invoices. This can involve implementing late payment fees to discourage overdue payments or offering discounts for early payments as an incentive. It's also important to maintain open communication with customers who are late in making payments. Understanding their situation can help you find mutually beneficial solutions and maintain good customer relationships.
Learn more on how to effectively deal with late payments and difficult debtors here.
Dealing with unpaid invoices is like navigating a tricky stretch of road. It requires attention, skill, and sometimes a little patience. But with the right strategies, you can clear the path and keep moving toward your goal of reducing DSO.
Step 3: Streamlining Invoice Management
Step three in our DSO reduction journey takes us into the world of invoice management. Digitizing the invoicing process is like upgrading from a manual to an automatic car. It brings numerous benefits, including:
- Speed: Digital invoices can be issued and delivered instantly, speeding up the entire billing cycle.
- Accuracy: Automated systems reduce the risk of human error, ensuring that invoices are accurate and clear.
- Efficiency: Digital invoicing eliminates the need for physical paperwork, making the process more efficient and environmentally friendly.
- Visibility: Digital systems provide real-time visibility into your invoicing, making it easier to track and manage.
If you are not fully convinced by these benefits, take a look at the 10 reasons why you should focus on Digital Debt Collection this year.
Now let’s get back to invoicing. Implementing digital invoicing for faster payment processing involves only 4 steps:
- Choose the Right Software: Look for invoicing software that fits your business needs. It should be user-friendly, secure, and offer features like automatic reminders and easy payment options.
- Train Your Team: Ensure that everyone who will be using the software is trained on how to use it effectively.
- Set Up Your Invoicing Process: This includes setting up your invoice templates, payment terms, and reminder schedules in the software.
- Communicate with Your Customers: Let your customers know about the change to digital invoicing. Explain how it will benefit them, such as by making it easier to pay and keep track of invoices.
Step 4: Investing in software
Arrears management software plays an increasingly pivotal role in streamlining collections and reducing DSO.
These tools use automation to eliminate the need for manual data entry, reduce errors, and speed up the invoicing and collection process. This not only improves efficiency but also frees up your team to focus on more strategic tasks.
Moreover, these software solutions provide valuable insights into your DSO and other key financial metrics. With real-time data at your fingertips, you can make informed decisions and quickly adjust your strategies as needed. It's like having a dashboard that gives you a clear view of your financial health at all times.
Another significant advantage of accounts receivable software is its ability to enhance customer relationships. Automated reminders, easy payment options, and personalized communication can improve the customer experience and encourage prompt payment.
At Arrears®, we can help you reduce your DSO through a state-of-the-art arrears management platform that combines human expertise with AI capabilities. Here are some of the top functionalities of the Arrears platform that can help reduce DSO:
- White-labeled Payment Portal: Arrears offers a truly white-labeled experience, allowing you to maintain your brand identity without having to create a cumbersome internal payment processing system or use a third-party provider.
- Omnichannel Communication: Arrears automatically identifies the best channel and time for communication with each debtor, saving you the headache of testing and optimizing individually.
- Personalized Collection Campaigns: With Arrears, you can easily design tailored debt collection campaigns for varied accounts, debts, or sources of debt. Use optimized, AI-generated templates to save time on copywriting.
- Data-Driven Calls: Arrears leverages an algorithm trained to pinpoint debtors with the highest ROI and make highly converting collection calls directly from the platform.
Reducing DSO is not just a financial goal. It's a journey toward a more efficient, resilient, digital, and profitable business. It's about navigating through the complexities of accounts receivable with clarity, strategy, and the right tools at your disposal.