Days Sales Outstanding (DSO) | B2B Finance Glossary
What is Days Sales Outstanding?
Days sales outstanding, commonly abbreviated as DSO, is the average number of days it takes credit sales to be converted into cash or how long it takes to collect account receivables (AR).
How do you Calculate DSO?
To calculate DSO, divide the average AR balance during any particular time (usually monthly, quarterly, or annually) by the total value of the credit sales during that same period. Then, multiply the result by the total number of days in that given period.
Here is the formula for DSO:
DSO = (AR Balance/Total Credit Sales) X Days in the Period
A low DSO score means that it takes a business a relatively short amount of time to collect outstanding receivables. A high DSO means it takes a relatively long amount of time to collect outstanding receivables. Usually, a DSO under 45 days is considered low, but a high or low DSO is relative to and entirely dependent upon the industry in question.
Cash sales are not included in DSO calculations because they are considered zero DSO: there is no time needed to wait from the date the sale is made to the time to cash is received, so including cash sales in your DSO formula will reduce your final answer and give you an inaccurate calculation of your company’s DSO time.
You can also look at the receivables that have been paid on time to calculate your Best DSO. This will show you the best possible DSO to expect if your company is always paid on time.
Here is the formula for the best DSO:
Best DSO = (Current Receivables/Total Credit Sales) X Days in the Period
If you want to determine exactly how late your customer’s late payments are, you can use average days delinquent (ADD) in addition to your DSO calculations. Calculating your ADD allows you to see how late payments from your customers are at any particular moment in time.
Here is the formula for ADD:
ADD = Average DSO – Best DSO
Why is DSO Important?
DSO is important because it’s one of the three major metrics that’s used to calculate any business’s cash conversion cycle (CCC). It can be critical for companies that rely on immediate cash flow to survive – especially for small and medium-sized businesses that don’t have diversified income streams.
While companies in different industries tend to have different DSO times, decreasing DSO is extremely helpful for finance teams across the board. That’s because the shorter the DSO period, the more quickly companies can access their mission-critical revenue and use that money to plan for the expansion of their business.
DSO can also help identify customers who are not creditworthy. Finance teams can look to see which customers lag on their payments and then implement specific strategies or policies to improve that particular customer’s payment time.
These changes can be made clear to customers through the company’s credit policy or a customer support call or email. They should also be communicated effectively to all future customers so that the problem can be avoided going forward.
How is DSO Related to Your Business Operations?
DSO is a valid indicator of how liquid your business’s current assets are at any given time. Having capital on hand that’s readily available to be spent is essential not only to the solvency of any business but also to the business’s growth and expansion. On top of that, DSO can help finance teams predict cash flow and properly plan for future expenses.
Additionally, keeping an eye on how DSO trends change over a series of months or quarters can show you how you need to adjust your company’s operations based on available cash flow.
It’s clear that the ability to collect outstanding receivables quickly can absolutely change the game for your business, which means that a low DSO is correlated with effective business operations, accurate financial modeling, and the ability to scale.
How Can You Reduce Your DSO?
There are a few different ways to effectively reduce your DSO:
Incorporate More Automation
Although many organizations use accounting software suites to manage the financial side of their businesses, much of the overall AR process is often still paper-heavy and labor-intensive. In order to effectively reduce your DSO, you must incorporate as much automation as possible into your operational processes.
By using a cloud and blockchain-based payment solution like Paystand, you can eliminate repetitive processes and easily scale to manage growing invoice volume. Automation means that invoices are sent to customers immediately, and digital payments are collected instantly with just the click of a button.
Expand Payment Options and Links
Sometimes it can seem that customers are hunting for any excuse to avoid paying a bill. One thing you can do to ameliorate this is to reduce the number of possible excuses by expanding the payment options you can accept. If you can accept credit card payments, ACH, paper checks, and direct bank transfers, customers will be more likely to find a payment option that matches their preferences. In addition, introducing digital flexibility, ease, and speed can help customers begin making the shift to paying in the ways your company prefers to receive money.
The Paystand Bank Network offers fee-less, bank-to-bank transfer options alongside credit card options that carry a convenience fee to help cover your transaction costs. When you offer customers the right incentives and give them an opportunity to experience a payment process that’s even easier than what they’re used to, you’ll be able to initiate a shift to payment options that will help you reduce your DSO even further.
Be Creative With Payment Terms
Although it is generally acceptable to offer 30-to-60-day payment terms to customers in many industries, there’s no reason that you can’t incentivize earlier payments. Customers are already accustomed to paying late fees if they remit invoices outside their agreed-upon payment terms.
Getting payments faster benefits your organization, so it’s reasonable to share some of those advantages with early-paying customers. For example, consider offering discounts for quick payments or rewarding those customers who consistently pay earlier with sneak peeks at new products or services or special rewards.
Be sure to communicate your payment terms clearly upfront and explain the benefits of paying early and the penalties for late payments. This will help shape customer behavior.
Use AI to Personalize Collections
Artificial intelligence (AI) and machine learning (ML) technologies can provide a wealth of data to help you personalize collections processes. For example, AI and ML can analyze a customer’s risk profile based on past behavior, payment history, communications preferences, and more. By using this information, you can create more effective outreach based on payment terms, types of receivables, and other particular customer categories.
Automating the collections process in this way allows you to be more diligent about collecting past-due accounts with less effort, which will lead to lower DSO.
Let go of High-risk Customers
The bottom line is that customers who routinely fail to pay their bills are simply not good customers to have. Use your system to track those customers who regularly pay late or not at all – especially clients who are unresponsive to outreach and communication efforts. You can also use the ADD formula above to see exactly how late these payments are and then use this data to see how much your business is truly being impacted.
If these late payments are starting to drag down your bottom line, it’s time to stop doing business with high-risk customers. Although this means potential lost income in the short term, your organization will save countless hours trying to manage those accounts and collect payments in the long term. Then, that time can be better spent working with customers who have short-term payment issues, improving customer service for your best customers, or acquiring new customers that are more diligent about paying invoices on time.
As you implement one or more of these initiatives to reduce your DSO, remember that you’ll need to implement continuous training, education, measurement, and recognition to keep your company focused on sustained change. And if you’re ready to reduce your DSO by as much as 80%, you can schedule a time to speak with one of our payments experts here.