At the core of high-performing companies is a tightened focus on financial health. The ability to forecast cash flow is crucial for taking advantage of opportunities, advancing revenue growth and developing resilience – valuable traits in an uncertain economy.
Organizations with a healthy cash flow often excel in three areas:
- Scheduling and planning new investments
- Rapidly adding new products and services
- Managing emergency expenses
To achieve this, your organization needs smart cash flow management, which requires a focus on key drivers of cash: accounts receivable (A/R), accounts payable (A/P), capital expenditures and debt services. One of the key indicators of your company’s cash flow status is the Days Sales Outstanding (DSO) metric, calculated by dividing the total accounts receivable by the total credit sales, then multiplying that result by the number of days in the period you are measuring.
An average DSO is 53 days, according to Celonis’s 2021 State of Business Execution Benchmark Report, based on an independent survey of 2,000 business leaders across six countries and eight industries. The top-performing companies surveyed achieve a DSO of 24.1.
So how can your organization improve its DSO? Here are some suggestions:
1. Set realistic expectations
Knowing your DSO status inside and out is essential. Perform a benchmarking analysis that shows how your organization’s DSO compares with the competition as a first step toward setting your DSO key performance indicators (KPIs). Information from industry resources and credit reporting companies can help select the right benchmark, too.
Another benchmark to consider is your company’s terms of sale. If your DSO results vary by wide margins from your terms, it can be an indicator of poor collections or non-competitive sales terms.
2. Deal with unpaid invoices
According to the Celonis benchmark report referenced above, on-time payment of suppliers happens only 50% of the time. In an uncertain business climate with frequent economic downturns, it is likely that this is due to the challenges companies face in closing its own invoices on time.
A way out of this issue is to adopt a proactive approach to collections that demands better use of data. This includes getting rid of inefficient processes and unifying fragmented data sources. Doing so can alter the ways A/R teams prioritize payments and mitigate the chances of delayed payments.
Relevant data analysis provides meaningful insights to identify invoices that greatly impact KPIs. For instance, the optimized utilization of process mining helps in identifying and eliminating execution gaps, equipping A/R teams to prioritize invoices based on outcomes.
3. Streamline invoice management
Updating your invoicing process from paper to digital is a sustainable way to improve your DSO. Paper invoicing is manually intensive – it requires preparing and printing an invoice, sending a physical copy to the customer, then waiting for the customer to send you a payment, along with mailing delays and risks. This method also delays customer feedback on invoices that require formatting revision or line-item correction – many times stalling the A/R process completely due to a customer’s lack of response for an incorrect document.
Digitizing invoices improves data accuracy and reporting, while speeding up your company’s ability to send and receive documents. This significantly reduces DSO, as customers are likely to pay faster for accurate and complete invoices received in the right format.
4. Perform credit evaluations
In an unpredictable economy, companies must recognize the importance of setting a budget and sticking to it. For A/R teams, this means mitigating financial risk. Determining customer creditworthiness before extending credit is an important consideration to ensure timely payments.
Know your customer’s credit scores and understand their cash flow situations (review their cash flow statements and debt-to-income ratio) before offering them payment options. This is part of an effective credit analysis and will clarify the customer’s ability to pay for goods and services.
5. Define payment terms
A company’s A/R typically consists of multiple invoices with varying payment terms. If these payment terms are not closely aligned to DSO goals, it can impact collections. Companies should, therefore, clearly define when it expects to be paid in its contractual agreements. For example, consider adding the invoice due dates and preferred payment method and currency.
It is also necessary to define when the company will provide discounts for faster payments or charge for overdue payments. Once the payment terms are agreed upon, A/R teams can do continuous follow-ups for prompt payments, while maintaining healthy relationships with your customers.
The DSO metric matters
When companies step up its DSO reduction efforts, the reward can include a strengthened stream of cash flow. With uncertainty becoming the new certainty, it is important for entrepreneurial organizations to set attainable and sustainable goals for DSO.
Breaking organizational silos and having the right systems, technologies and process efficiencies in place naturally improves collection effectiveness. A regular review of DSO metrics can help keep the focus on what KPIs matter most.
How Sikich can help
We’ve worked with hundreds of entrepreneurial organizations in growth mode to build sound financial foundations. We can review your A/R processes to understand your challenges and provide solutions that support your cash collections, empowering your business with the resilience it needs in today’s market. Contact us here:
