How to reduce your DSO?
The most widely used measurement tool in the world of credit management is the Days Sales Outstanding (DSO). The DSO measures how long it takes on average for a company to receive payment of an invoice after a service or product has been delivered to the customer.
A high DSO means that a company is selling its products or services on credit and this may lead to cash flow problems.
After many years of being in the business of credit management, we know a little bit about what reduces DSO. On this wiki page we will give you tips and tricks to help you reduce your Days Sales Outstanding.
What does DSO tell you?
Companies with a low DSO have the strongest levels of cash flow and do not face a credit risk. However, companies with a lot of unpaid invoices face increasing levels of risk; the longer the wait for payment the higher the risk of default of payment. But what is a good DSO ratio?
There are different ways to calculate your DSO.
DSO = (open invoice amount or accounts receivable / total value of sales) * period in days,
The total amount of your accounts receivable is measured at the end of the given period.
Let’s say you want to calculate your DSO per month. At the end of June the total amount of your open invoices is € 80.000,-. And at the end of July it is € 60.000,-.
In order to calculate the total value of your sales, you can use the turnover in a given period. It is important to know the details of your turnover.
If there are fluctuations in your sales, the DSO will fluctuate too. We will give you an example:
Your turnover is €88.000,- in June. And only €40.000,- in July.
Your DSO over June would be €80.000,- / € 88.000,- * 30 days = 27,3 days.
Your DSO over July would be €60.000,- / € 40.000,- * 30 days = 45 days. For a company with this fluctuation in turnover it is wiser to use the average monthly sales over 12 months.
Generally, a DSO below 45 is considered low, but this depends on the type of business you are in and the business structure that you have. Different industries have different average DSO’s. So, a ‘good’ DSO in one industry may be a ‘bad’ one in the other.
Six tips and tricks to reduce your DSO
- Bill your customers directly after delivery of your product or service. This does not only help in the obvious way of being paid earlier, the willingness to pay is also greater directly after delivery of your product.
- Be as precise and specific as possible on your invoice. It avoids questions about your invoices and it reduces the chance of having to send a new invoice.
- Make it easy for your customers to pay your invoices. Add the possibility of direct debit for future invoices. Or add credit card or other payment methods like PayPal to your invoices.
Not only consumers use these payment methods. Also small businesses use them more and more.
- Give your clients an easy way to respond to an invoice. If something is unclear or a payment plan is requested, you would like to know this as quickly as possible. The sooner you know, the sooner you can resolve an issue and get paid
- Send automated payment reminders immediately when an invoice is past its due date. Don’t think that your relationship is at stake. The way you chase your open invoices also determines the quality of your product to some extent. In other words, if you do not chase your overdue invoices professionally, your product is perceived as less valuable.
- If a customer is still not paying in time after implementing the above mentioned five tips and tricks, ask your customer to leave. This customer deserves your competitor. Good companies gather good paying customers.
Companies need a positive cash flow to run their business. And a lot of cash flow problems can be avoided through a good strategy. It is important for the continuity of your business to organise your cash flow management properly.
DSO improvement is one solution. But if you are able to build a reliable company, money is cheap. Good debtors can be your financial collateral to cheap temporary money. Without resorting to expensive factoring.
Thanks for reading this article. Please contact us if we can be of any help improving your cash flow.
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