Understanding Days Sales Outstanding (DSO) - Definition and Uses

Higher Days Sales Outstanding Number?         

A higher days sales outstanding number indicates that a business is selling its goods and services on credit to its customers and taking a long period of time to collect that money. The effect of taking long to collect money from credit sales means that the business will have cash flow problems.

Large businesses may not have serious cash flow problems with a higher days sales outstanding number because of the volume of transactions or sales they handle in any particular period. Small businesses however may have serious cash flow problems if they have a high days sales outstanding number, because such small businesses rely on quickly collecting of money to make payments for their operational expenses such as utilities and salaries.

Lower Days Sales Outstanding Number?

A low days sales outstanding number indicates that a business takes a short period or fewer days to collect cash from its credit sales. This is usually a good sign because the business collects cash sooner from its customers and is able to utilise that cash for its operations.

A low days sales outstanding number may also be a sign that a company has a rigid and strict credit policy which maybe discouraging to its customers. This leads to strained relationships with customers and might therefore affect the performance of the business. A business can avoid such a scenario while maintaining a low days sales outstanding value by offering discounts to customers who pay earlier than their due dates.

• Analyse Current Days Sales Outstanding Status

A business that is keen on reducing its days sales outstanding should begin by collecting data about its current days sales outstanding status. This data should be analysed by creating a benchmark that shows the business’s level of days sales outstanding average and how it compares to other businesses in the same industry and of similar stature.

This insight provides a starting point for evaluating the business’s days sales outstanding and also provides an idea of what days sales outstanding average is achievable for the business. This data can be used by the business’s accounting executives to make a case for prompt collection of accounts receivable and reducing the days sales outstanding to the senior management or business owners. The business’s management can make a justification for devoting resources to improving the accounts receivables management and collection process.

• Incentives for Early Payments

A business can increase its cash flow by offering its customers incentives for making early payments. Discounts for early payments are known to hasten the payment process. These discounts can be offset easily by increasing cash flow, savings on loan fees as well as more discounts from creditors. A business can reduce its days sales outstanding by communicating and informing its customers of these incentives so that they would not need to be reminded or prompted to make early payments.

• Penalties for Late Payments

A business can also reduce its days sales outstanding average and improve its cash flow by penalising those customers who are consistently late with making payments. This can be done by ensuring that invoices contain late fee terms and conditions so that the customers are well aware about them from the onset.

• Offer More Payment Options

By offering customers a variety of payment options, a business can get paid faster because the customers will choose the method of payment that is convenient for them. Different payment options that can get a business paid quicker include, card payment, online payment and bank transfers. These should compliment the conventional methods of payment such as cash and cheques.

• Automating Invoicing

A business can reduce its days sales outstanding for better cash flow it invests in an online invoicing and billing software. Having an online invoicing system will allow a business to be organised and systematic in the way it issues invoices to its clients and collects payment. With such a system, a business can issue an invoice to a client as soon as a sale has been made thus reducing delays in collecting payments. A delay in sending invoices to customers has a net effect of delaying payments further.

An automated invoicing software allows a business to track payment status as well as send out to customers automated payment reminders. It also allows a business to customise its invoices according to its individual customers. An online or automated invoicing system will help the business collect payments faster and in effect reduce its days sales outstanding.

• Letting Go Of Bad Customers

A business that has customers who consistently delay, or refuse make on payments on time will definitely have cash flow problems. It is therefore important for a business to re-evaluate its relationship witch such type of customers because the cost of retaining that customer will not be helpful to the business in the long run. Bad customers will affect the days sales outstanding and therefore have an impact on a business’s cash flow.

• Saving Customers’ Credit Card Details

A business that offers digital recurring services to its customers can make sure they pay on time by saving or storing their credit card details. This ensures that the customers are charged immediately their invoices become due. It is however important for a business to inform its customers of this policy beforehand and obtain their consent. It is also important to notify them before and after charging their credit cards.

• Managing the Invoicing Process

Accounting processes that are slow, inefficient or ineffective also have a negative impact on the days sales outstanding of a business.  Therefore, in order to reduce the days sales outstanding and improve a business’s cash flow, focus should be on making sure that invoices are going out promptly and on time. The business should ensure that the invoices contain all the necessary information, and they do not have errors.

A comprehensive review of the entire billing and invoicing process can reveal errors or mistakes that can delay payment. Some of the common errors that can delay payments include wrong mailing addresses, incorrect charges and invoices that do not indicate agreed discounts.

A business that would like to improve its cash flow by reducing its days sales outstanding average should regularly review and update invoicing policies and process particularly on when to send invoices to customers and ensure that those policies are strictly followed. The business should also regularly audit the invoicing processes to identify any possible delays or errors.

• Managing the Accounts Receivable Process

A business without a plan for following up on outstanding invoices cannot have a good and steady cash flow. There needs to be a proper plan for following up on payments once an invoice has been sent to a customer. The accounts receivable process should have a  communication component that focuses on identifying any problems or challenges that are hindering the customer from settling the invoice on time. Sometimes an otherwise good customer could be having cash flow problems which are affecting his or her settlement of invoices. Good communication between the business and the customer can identify these challenges and allow the business to provide a special payment plan for that customer.

If the non-payment by the customer continues for a long period without solutions, the business should have a clear policy for handling these cases and any disputes that may arise. This policy may include forwarding unpaid invoices to a debt collection agency. This policy should be clear and well communicated to the customer.

• Maintaining the Momentum

Regularly reviewing and auditing the invoicing and accounts receivable process is just part of the process of reducing a business’s days sales outstanding. In order to improve cash flow, the business must commit to reducing the days sales outstanding and sustaining this process in the long term.

Improving cash flow and reducing the days sales outstanding average requires habit changes together with changes in the administrative and accounting processes. Businesses  therefore need to ensure that these changes stick, and business executives do not go back to the old ways. Businesses need to conduct regular reviews, discussions and meetings about the days sales outstanding metrics so that they can reinforce the importance of these numbers to the business.