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DSO stands for Days Sales Outstanding, and it's a measurement that determines how long, on average, it takes for your customers to pay their invoices.
Business

The Dreaded “DSO”: How It's Harming Your Business & What to Do About It

If you're a business owner, there's a good chance that you've heard of DSO. DSO stands for Days Sales Outstanding, and it's a measurement that determines how long, on average, it takes for your customers to pay their invoices.

It is essential because the longer it takes them to deliver, the more capital you have in accounts receivable. If they take too long to pay and your other costs are still rolling in, your business can be precarious.

You might think your DSO is healthy right now if all of your customers are paying on time, but just because they're paying doesn't mean there isn't room for improvement.

What is a Healthy DSO?

There's no universal answer to this question—it depends on what industry you're in and how much liquidity you need at any given time. However, our experts generally agree that a solid DSO is somewhere between 30 and 50 days.

DSO is one of the most common metrics companies use to measure their financial health and track cash flow.

Publicly traded companies that report quarterly must disclose their DSO in their quarterly earnings reports.

For these companies, if they don't meet targets or are trending in the wrong direction, investors will get upset, and the stock price will fall. And even if they are doing well, investors analyze this metric carefully to see how it compares to competitors.

Private businesses can also benefit from tracking DSO closely because it helps you stay on top of your cash flow. For example, if you see that your DSO is starting to rise over time, you may want to take action to collect more quickly to make sure you have enough money coming in for operating expenses.

The big problem with DSO is that it varies wildly from month to month, depending on many different factors. As a result, it isn't easy to get an accurate picture of your company's cash flow by looking at just one month of data.

No matter how good your business is at collecting overdue invoices, there will always be some customers who pay late. And while most companies can usually compensate for a few late payments here and there, when this becomes a monthly issue, it can wreak havoc on your company's cash flow.

It is why it's essential to keep track of how quickly your customers are paying their bills. Once you know how long it takes for a client to pay an invoice in full, you can make adjustments and improvements to increase your profits and keep your business running smoothly. This is where DSO comes in.

How to calculate DSO

Calculating DSO is relatively straightforward. You divide your company's accounts receivable during a set time frame by the total value of credit sales made during that time frame and multiply by the number of days in the time frame.

DSO = (Accounts Receivable / Total Sales) x Number of Days

So, to break down what this equation means, let's look at an example. Say your company has $1,000,000 in total sales in the past year, and you have $200,000 in accounts receivable over that year. You can calculate your DSO like this:

$200,000/$1,000,000=0.2 x 365 days = 73 days.

When is it relevant

It would help if you cared about your DSO when you want to make improvements in any of the following areas:

Cash Flow

By monitoring your DSO, you can identify if there is a lag in converting the sales into cash. If your DSO increases over time, the average number of days it takes for customers to pay has increased. It could mean that customers are taking longer to pay each invoice. If this happens, the amount of cash available for business operations decreases.

Financial Risk

Managing risk is an essential part of running a business. When you calculate your DSO, you can take measures to reduce risk and ensure that your company will be able to stay in operation and grow. You may find that some customers are taking longer than they used to or have been making late payments more often than average. You can use this information to change their payment terms or decide not to work with them to minimize risk.

Benchmark your Company Against Competitors

By comparing your DSO against competitors, you can see how well you are operating compared to others in your industry or market segment. If it takes longer for customers to pay than other companies, you may need to look at ways to improve your payment terms and collection process. After all, if your customer does not pay on time, that can lead to cash flow problems and even cause financial issues such as late fees, penalties, and interest.

Analyze your Liquidity

When you are looking to understand your company's liquidity, you need to consider your cash flow. When you know your average days' sales outstanding, you can predict how much money will be in your accounts receivable at any given point in time. It will help you understand how long it could take before the money flows into your bank account.

Establish a Working Capital Threshold

By calculating your DSO and then comparing it with previous measurements, you can see how well or poorly your company is doing. Then, you can decide whether or not you need to implement a different strategy for collections. For example, if you notice that your DSO is moving upwards every month, there may be an issue with the collections or terms.

Determine Whether Your Terms are Appropriate

If you decide that the DSO is too high, it might indicate too lenient terms for specific clients. This can hurt company liquidity. However, if the payment terms are too short, it can hurt your brand's reputation and drive away potential customers, who might assume that doing business with you will always be a hassle.

When is A DSO not Relevant?

DaysSales Outstanding is vital to companies that sell on credit, such as wholesalers, retailers, and manufacturers. But the DSO is not always the most relevant metric in specific industries and may even be harmful to your business if you focus too much on it. Here are some ways the DSO may not be relevant:

If you have many zero-balance customers

The DSO can get skewed when you have a lot of zero-balance customers in your dataset. These accounts should be excluded from your DSO calculation since they aren't making payments.

For specific industries

TheDSO doesn't mean much for specific industries where clients book sales months or even years in advance. There may be no correlation between days to pay and overall financial performance in these cases.

For certain businesses

Certain businesses have unique economic models that don't require credit terms.Consulting firms, agencies, and professional service providers often bill their clients in advance or at the time of service delivery. If this sounds familiar, then calculating a DSO may not be relevant to the success of your business.

How to Optimize DSO

Your business has many moving parts, but if you want to keep your operations running smoothly, then one number you need to pay close attention to is DSO (days sales outstanding). Optimizing your DSO will help generate better cash flow and improve your ability to maintain operations, make investments, expand, etc. But how do you do so? Here are some tips:

Work with your sales team to set clear payment terms and conditions with clients.This way, you will know what to expect from the start rather than having to play catch-up halfway through the process.

Establish a payment reminder process. According to research, many consumers say they would be willing to enroll in reminders for due payments.It's never a bad idea to ask clients if they'd like them!

Look for ways to shorten the time between delivery and payment. If there's anything in the system that you can streamline, it could help prevent delays from impacting your DSO.

Improve your collections process by ensuring you have a system in place for collecting payments and following up with clients who haven't paid yet.

Be more proactive in your outreach to customers about their unpaid invoices. Don't wait until they're way past due before you contact clients—this can put them on the defensive and make it harder for you to collect.

Be more diligent about monitoring your DSO. Keep an eye out for trends that could impact it—like if certain services tend to have longer wait times than others—and work quickly to resolve any issues before they worsen.

What are your next steps?

While there is no one solution to reducing your DSO, there are some things you can consider:

·  Review your credit and collections policies.Are they working, are you following them, and is there room for improvement?

·  Look at the best practices of companies with a lower DSO than yours. What are they doing that you might implement in your business? Learn from other successful companies!

·  Evaluate the terms you offer customers. Could offering longer payment terms be an option for customers to take your product or service, resulting in increased revenue and customer satisfaction (and a lower DSO)?

You now have some critical insights into your cash flow and what you can do to improve it. If you have a better grasp of your cash flow but still want to improve it, consider our software offering: Dryrun.

It helps companies like yours understand and manage their finances more efficiently. We provide a tool that is easy to use yet flexible enough for most businesses needs.

Dryrun delivers clear, actionable forecasts in a fraction of the time you spend in spreadsheets.

Book your discovery call to learn about the Dryrun advantage.

See if Dryrun is a fit for you.