Why you should care about reducing your DSO

Oct 21, 2021 by Brandon Jones

Many companies struggle with the problem of getting customers to pay invoices in a timely manner. On-time payments are extremely important to a business’ cash flow. Since understanding the details of customer payments is the first step towards improving cash flow, many companies keep track of days sales outstanding (DSO).

DSO averages the time it takes for your company to receive revenue. A low DSO means that, in general, your customers quickly make their payments. Conversely, high DSO means that customers tend to delay payments. High or rising DSO values can indicate issues in your accounts receivable process that you need to address.

Understanding DSO

Understanding what DSO is, where your company’s DSO is currently at, and where your DSO should be are crucial to making financial decisions.

The average DSO for businesses around the world tends to be around 65 days, according to a study by Euler Hermes. But simply comparing your business’s DSO to this average won’t prove very helpful. Many other factors need to be taken into account.

Finding Your DSO

First of all, you’ll need to find your company’s DSO. Start by deciding on a reporting period. A monthly period is usually a good option. Then, find your accounts receivable balance for your chosen period and divide that number by total credit sales. Finally, multiply your answer by the number of days. This value is your DSO.

Other Factors

Just looking at the number isn’t very helpful. DSO numbers can span a wide range over different industries. To really understand your DSO, you’ll need to compare it to other companies in your industry.

For example, if your particular industry has a low average DSO, 65 days might not be a good score. You’ll want to consider making an effort to reduce your DSO to match other companies of similar size. However, a DSO of 90 days might not be as bad as it looks if you’re in an industry where high DSOs are common. In that case, it may not be worth it to spend time and energy on reducing your DSO.

If your company experiences seasonal fluctuations, you’ll want to take that into account as well. Your DSO value in June could be completely different from your DSO value in December. It may be a good idea to factor your DSO based on a quarterly or yearly time period to account for these types of changes. This will yield a more accurate DSO.

What High or Low DSO Values Mean

Now that you’ve benchmarked where your business’ DSO ought to be, compare it to competition. If you have a comparatively low DSO, your customers are diligent about paying on time and your business should have good cash flow. Trying to reduce your DSO probably isn’t worth your time.

However, if your DSO is higher than average, you’ll definitely want to consider taking some serious steps to change it.

Disadvantages of a High DSO

Having a high DSO, or, even worse, a steadily rising DSO, means that your customers are slow about paying invoices. Doing nothing about a high DSO can result in poor cash flow, bad customer habits, and overall inefficiency.

Cash flow is essential to running a successful business. When customers delay payments, cash flow is compromised. That, in turn, makes business improvements and investments difficult or impossible. This ultimately hinders the success of a business.

If you don’t do anything to reduce a high DSO, customers will start thinking that late payments are acceptable. Delaying becomes a habit that eventually puts your company at a huge disadvantage.

Accepting poor DSO values will increase overall business inefficiency. Improving your DSO is a simple way to increase your business’s chance of success. Many options are available to help you along the way.

Ways to Reduce DSO

Now that you know where your DSO is and where you want it to be, it’s time to start taking some serious steps towards reducing your DSO. Improvement is possible in many different areas, whether you decide to clear up communication, offer incentives, or automate invoices.

Here are some effective ways to improve company DSO.

Automating Invoices

The faster that customers receive their invoices, the less time it will take for them to pay. As a result, automating your billing processes can be a very effective way to reduce DSO.

Automation saves time on both ends. On the business end, invoices can simply be sent out more quickly. But automation also eliminates the possibility for human error, which means that customers are receiving accurate, clear, and concise information. Better communication through automation often reduces delays due to customer confusion.

Automation can also help with properly complying with customer invoice requirements. Customers often use order numbers when purchasing items, so invoices may get lost if they don’t match up with valid order numbers. Be sure to obtain plenty of information about customer preferences for invoices, such as how invoices should be delivered, preferred contact information, and when payments are generally made. If invoices are consistent and regular, mistakes and delays are less likely to occur, which will in turn reduce DSO.

Editing and Communicating Payment Terms

At this point, it may be a good idea to rethink your payment terms. When you allow customers to wait weeks to pay, it becomes the accepted norm. Consider requiring sooner payments. You may lose some customers as a result, but it could save your company time and money in the long run.

Customers often have legitimate reasons for paying late, and confusion can be a big one. If customers are often calling customer service with questions about payment terms, ensure that your terms make sense. Having clear, simple payment terms that customers can access and understand is an easy way to reduce customer confusion.

If your invoicing software allows it, try including your payment terms in every single invoice. That way, information is readily available for customers to reference as they complete the payment process.

Sending Reminders

It’s often easy to forget about payments. A high DSO doesn’t mean that customers are intentionally procrastinating about paying up on accounts receivable. It could be simple, honest forgetfulness, which is something you can help fix.

Friendly reminders can keep customers accountable and up to date on payment status. These should be sent out regularly after the initial invoice. They can contain information about the payment process, the payment terms, any relevant deadlines, and any rewards for early payments.

Following up on invoices can be done in a variety of ways, such as emailing, texting, and calling. It might be a good idea to use a variety of options, as different customers may prefer different modes of communication. When you use a service such as Paystand, you can easily embed a “pay now” button on every invoice and reminder.

Offering Incentives

Offering rewards can help incentivize early payments. For example, you could offer discounts to customers who pay within 10 days, or you could offer sneak peeks at new services or products for customers who consistently pay early.

Make sure there are also consequences for paying late. If customers aren’t penalized in any way for late payments, there’s no reason to make the effort to pay on time.

Offering Different Payment Options

Digitizing your payment process by offering digital payment options tends to make things easier for both the company and customers. Since paying online takes very little time, customers don’t need to carve out hours to figure out a complicated paper billing system. As a result, making payments is much faster and easier, which encourages customers to submit payments promptly.

Obviously, not all customers will opt for this choice, so be sure to offer other payment options too. You may want to consider accepting electronic payments, credit cards, and paper checks so that customers can choose the payment method that’s most convenient. Businesses can steer customers toward low-cost payment options. For example, Paystand’s bank-to-bank network is free, which can motivate usage, especially if credit card payments carry a convenience fee to cover transaction costs.

Dealing With Late Payments

Sometimes customers miss deadlines or simply don’t pay at all. While this is annoying and often time-consuming to resolve, having a clear plan for what to do in these situations is key.

We can all be forgetful at times, so start with friendly reminders to help maintain a good relationship with your customer. If the delay was unintentional, your customer will probably pay as soon as possible. Remember that convenient, varied payment options with embedded “pay now” buttons in all communications can make the request easy to fulfill.

However, if multiple reminders don’t receive a response at all, you should consider walking away from the customer. It’s always difficult to get rid of potential business, but if customers are often late on payments they might not be worth the trouble.

Assessing New Customers

Customers are an integral part of any business. As a result, you should carefully consider them and think about whether or not they’re the type of clients you want to keep.

Removing problems before they begin will save you a lot of trouble later. Ways to assess customers include running credit reports and checking customer websites for poor reviews. This should help root out the most problematic customers before they begin to cause trouble.

Being too selective might be impossible for your particular company, but you should certainly set some parameters for new customers. Determine a minimum acceptable credit risk and accept potential customers based on it.

 

Looking to learn more ways to improve your cash flow and simplify your AR process? Check out our article on 5 easy ways to reduce your DSO.