Improve Your Cash Flow by Managing Your Accounts Receivable
Days Sales Outstanding (DSO) is a key performance indicator (KPI) used to monitor the length of time it is taking a business to collect their sales invoices. The KPI is also sometimes known as average debtor days, or average days to pay. DSO is calculated by dividing the accounts receivable (AR) balance by the credit sales in the period and then multiplying the resulting figure by the number of days. If your credit terms stipulate payment within 30 days, and your DSO is 50, that would indicate that you are not getting paid in line with your payment terms. The DSO is a crucial number to monitor, because a small change in the figure can make a significant difference to your cash flow. Here ten ways that you can lower your Days Sales Outstanding, which will improve your cash flow.
1. Tighten Up Credit Approval
Effective credit control procedures begin before you grant credit to a customer. If you have a high DSO and you frequently suffer bad debts, then you probably need to tighten up on your credit approval process. It is advisable to run a credit check on all new customers. Obtaining at least two references will also help you assess the creditworthiness of a customer. If a new customer does not appear to be creditworthy, then it would be best to demand cash with order on their sales.
2. Offer More Ways for Customers to Pay
The simpler you make it for customers to pay your invoices, the faster you will get your money. So, consider offering multiple payment methods, including direct transfer, credit cards, and PayPal. Offering numerous payment methods gives your customers more flexibility in how they pay you. So, if a customer doesn’t have sufficient funds in their checking account to make the payment, they could use a credit card to pay instead.
3. Improve Collections Procedure
The most obvious way to bring down your Days Sales Outstanding is to improve your collection procedures. Improving AR collections will usually involve closer monitoring of accounts receivable, chasing customers sooner, and being more persistent. Also, make sure that you send your customer statements out as close to the end of the month as possible. Some businesses will only pay vendor accounts when they receive a supplier statement.
4. Get Tougher Sooner
If sales invoices become seriously overdue, it is advisable to get tough with the customer sooner rather than later. You may be concerned that taking a tough stance on collections will result in the loss of some customers. Even so, a customer who does not pay you is of no benefit to your business at all. If a customer is experiencing financial difficulties, you will want to make sure that you are one of the creditors who does get paid. So, the sooner you escalate the collection methods, the more chance you will have of avoiding bad debt.
5. Offer Incentives
Offering a settlement discount is an excellent way to reduce your Days Sales Outstanding. But, of course, you will need to build any discounts you offer into your gross margin calculations. You can allow a settlement discount if a customer pays on time. You could also offer early settlement discounts as an incentive for customers to pay invoices before the due date. Although some customers may not take advantage of the settlement discounts, those who do will lower your DSO and improve your monthly cash flow.
6. Handle Dispute Mores Efficiently
Sometimes customers may have a legitimate reason for not paying their sales invoices. They may dispute invoices because of errors, or they may not be satisfied with the product or service they received. First, ensure that all invoices sent to customers are dispatched as soon as possible and are accurate. Then, start monitoring disputed invoices and take steps to ensure that disputes are settled swiftly. Customers may withhold payment of an entire account because they have disputed one single invoice. So, allowing that dispute to remain unsettled for a prolonged period could have a significant effect on your DSO.
7. Review Payment Terms
It is highly unlikely that all your customers will consistently pay on time or early. So, you can expect that Days Sales Outstanding will always exceed your credit terms. So, if the average length of time that customers take to pay is not fast enough to cover your cash flow needs, you might want to consider amending your payment terms, or you may wish to consider asking for a deposit or cash with order on some types of sales. If you want to amend your credit terms, though, you will have to consider your contractual commitments to existing customers. Alternatively, you could implement the new terms and conditions with new customers only.
8. Put Late-Paying Customers on Temporary Hold
If you supply a product or service that customers buy regularly, then putting a temporary stop on their account will usually get a late payer’s attention. If you apply a policy of placing sales accounts on hold consistently, customers will learn how far they can go before they get cut off. So, they will usually pay you just in time to avoid the suspension of supply. However, you may want to apply this tactic selectively and with caution. If you refuse to supply a valued customer, they may find an alternative supplier, and you could lose that customer’s business.
9. Close Accounts of Persistent Offenders
If a customer persistent pays you late, your option of last resort is to close their account and refuse to do any further business with them. When making this decision, you will, of course, want to consider the value of the customer to the company. But, if the late paying customer is only buying small volumes of low-margin products, keeping that customer may be more trouble than it is worth.
10. Review DSO Regularly
Reducing Days Sales Outstanding will have a positive impact on your cash flow, but the improvement will not be instant. You will need to make changes in your procedures, and you may need to make employees aware of the need for strict credit control. So, the reduction of DSO will be a long-term and ongoing project. Once you have achieved your DSO target, you will then still need to stay on top of your accounts receivable to ensure that the Days Sales Outstanding KPI does not creep up again.
The Bottom Line
Days Sales Outstanding is the best indicator to use to ensure that you are managing your accounts receivable effectively. And the above tips will help you reduce DSO over time. If you can close the gap between your standard credit terms and DSO, you will see an improvement in your cash flow.
About Universal Funding
Universal Funding is a private funding source that has funded thousands of businesses and more than $2 billion since 1998. We turn your accounts receivable into the funding you need through invoice factoring and can have capital in your hands in a matter of days.