How to Improve Cash Flow by Mastering Days Sales Outstanding
February 13, 2018
Are you struggling to grow your business due to a lack of cash? Don’t worry, there’s a simple solution and it involves managing your days sales outstanding.
You need cash to run your business, cover day-to-day costs, pay staff and settle loans. When cash flows in slower than it flows out (negative cash flow) running and growing your business can be difficult.
And, if you’re not careful you may find yourself in financial trouble. That’s not to mention the stress and anxiety it can cause you.
Guess what, though? There’s a solution and it involves mastering days sales outstanding (DSO). Let’s explore what DSO is, how you calculate it, why it’s important, how you can track it and ways to improve it.
But What Is Days Sales Outstanding?
DSO or days receivables is a fancy accounting word for a calculation that businesses use to estimate how many days – on average – it takes clients to pay their invoices.
It’s a financial ratio that tells you how well you’re managing accounts receivable and it’s usually calculated monthly so that you collect meaningful data over a period.
How Do You Calculate It?
To calculate the DSO ratio take your total accounts receivable and divide it by the average sales per day.
For example, if your business’ accounts receivable for the year were $2000 and the average revenue $25,000, your DSO is 29 days ($2000/ ($25,000/365).
What Do These DSO Numbers Mean?
Higher numbers mean that you have longer average collection periods. However, these numbers are meaningless on their own; you should compare them to your payment terms and average industry collection times.
If your payment terms are 30-days and it’s taking 45 days to get paid, this is a signal that you may need to address your collection procedures.
The same applies to industry averages. In an article on Inc., Sageworks compiled a list of 10 private companies and their average collection periods. “Foundation, structure, and building exterior contractors” had an average collection period of 67 days. It follows that if you’re in this industry and your DSO number is higher, you should fix this.
Why Should You Calculate Your DSO?
By tracking these figures monthly, you can identify if they’re increasing over time against your benchmarks and that of the industry.
Constant increases from month-to-month, especially those that fall out of the benchmarks, indicate that you may have an underlying problem:
- Customers may be unhappy with your services
- You may be targeting customers who aren’t creditworthy and can’t pay you on time
- Your payment terms on your invoices may be too long
- Your billing process may be inadequate with invoices not being sent on time, errors that cause back and forth, and failure to submit late payment reminders
The point is that you can’t improve what you don’t track. If you don’t know how long it’s taking your customers to pay you, you won’t know that there’s a problem until you no longer have cash on hand. Thankfully, by improving how you track DSO, you don’t have to experience this issue.
How to Better Track (And Improve) the Days Sales Outstanding Ratio
One of the best ways to track accounts receivable is to use cloud-based accounting software. FreshBooks, for example, lets you organize invoices in one place so that you can easily see what’s outstanding without having to wade through spreadsheets and emails.
You’ll know what invoices you’ve sent and what money’s outstanding. But accounting software such as FreshBooks doesn’t only help improve your DSO ratio through better tracking; it also helps in other ways.
You can use accounting software to:
- Automate your invoicing invoicing
- Set up recurring invoices to cultivate the habit of clients paying you at regular intervals
- Reduce errors on your invoices to avoid back and forth between you and your clients which can delay payment
- Make it easy for clients to pay you with a choice of payment method and integration with credit cards for prompt payment
- Send late payment reminders without lifting a finger. This is ideal especially if you don’t enjoy money talk.
Other Solutions to Improve DSO Problems
Focus on Getting Better Clients
Define your ideal client and be wary of red flags during the interview process. I could’ve avoided such a scenario in my own business had I paid attention when talking to this one client.
The client who was an agency said that they only pay once their clients pay them. After initially getting paid swiftly for the first invoice, I forgot about this. But as the relationship grew they started using the excuse: “We’ll pay you when we get paid by our client.”
Payment began being delayed for over a month. When you’re used to getting paid within a few weeks, and you know have to wait months, it can cause a severe blow to your cash flow.
Concentrate on the Details of the Invoices You Send
Make sure you specify the payment terms. Avoid ambiguous terms such as “net-30” as it can confuse those who aren’t business-minded
Also, consider including an incentive, so clients pay you on time. For example, you could give a 5% discount for payment within a few days
Request an Upfront Deposit
Upfront deposits make clients vested in the project. They also improve the likelihood that you’ll get the rest of your money, on time, without having to chase for payment.
Improving your cash flow doesn’t have to be difficult. In fact, by focusing on your days sales outstanding, you’ll have more cash on hand to run a thriving business.
Of course, you can’t improve what you don’t track. That’s why it’s so important that you track your DSO over a period against your business terms and industry benchmarks. You’ll then be able to identify the problems and find solutions to fix them.
One such solution is FreshBooks.
FreshBooks lets you organize your invoices in one place to see exactly how much money is flowing in and what invoices are outstanding.
What’s more, FreshBooks helps you get paid faster by integrating any invoice with the clients prefered payment method and by automatically sending late payment reminders for those overdue invoices.
So, why not try FreshBooks today? With a free 30-day trial you have nothing to lose.