Top 10 Strategies for Reducing Days Sales Outstanding (DSO)
Resolve to Master Cash Flow Management in the Coming Year
How was your accounts receivable (AR) performance last year? This is a very important question because AR is typically one of the top two or three largest assets for a B2B vendor. The primary way most companies measure AR performance involves looking at the Days Sales Outstanding (DSO) metric. Accelerating sales can increase DSO, but most often the cause is problems in the order-to-cash (O2C) pipeline affecting collections. If DSO is above acceptable norms and AR performance lagging, the impact can reach every corner of your organization.
The Consequences of Poor AR Performance
First and foremost, poor AR performance impacts your cash flow, which causes financial strain and operational challenges. A diminished cash flow creates liquidity shortages which impact an organization’s ability to meet financial obligations, increases the cost of capital if you rely in any way on borrowing to cover cash flow gaps, hinders your ability to invest in your company if you don’t borrow, and in general adds inefficiencies to day-to-day operations.
Here are some of the other consequences of an under-performing AR:
Revenue losses from uncollected accounts and bad debt write-offs
Negative impact on overall profits and your company’s growth potential
Increased administrative costs for managing collections and resolving issues, especially if legal action is required to recover funds
Diversion of resources from strategic tasks like sales and product development
Erosion of customer trust and credibility due to errors in invoicing and payment handling, potentially leading to the loss of revenue and customers
Loss of customers due to payment-related frustrations
In the worst-case scenario, persistent cash flow problems can drive a company into bankruptcy. While multiple factors can contribute to an organization's financial downfall, insufficient cash flow is typically the primary trigger for bankruptcy proceedings.
Ineffective AR management and poor performance inevitably result in cash flow challenges. When these issues are not promptly addressed, they can threaten a business's long-term viability and survival. However, B2B vendors can mitigate these risks and enhance their overall financial health and operational efficiency by:
Improving AR management practices
Implementing automation solutions
Developing strategic policies to address cash flow issues
By taking these proactive steps, companies can safeguard their financial stability and reduce the likelihood of severe financial distress.
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The Top Ten Ways to Reduce DSO and Improve Cash Flow
By implementing strategic measures to decrease DSO, companies can unlock significant benefits, including improved liquidity, reduced reliance on external financing, and enhanced overall financial performance. The following ten strategies offer a comprehensive approach to tackling DSO challenges, combining technological solutions, process improvements, and customer-centric practices. These methods have been proven effective across various industries and can be tailored to suit the specific needs of different businesses.
Here then are the top ten ways to reduce Days Sales Outstanding (DSO) and improve cash flow:
1. Automate Billing and Accounts Receivable Processes
Implementing automation in your billing and accounts receivable processes can significantly reduce DSO. Automated O2C systems can send out invoices faster, eliminate human errors, and provide a superior customer experience. This leads to quicker payments and improved cash flow. While automating things like remittance processing, credit application processing, and portfolio monitoring and analysis will help you improve DSO, there are two types of automation solutions that are proven to significantly improve cash flow. Implementing collection workflow software delivers immediate and significant cash flow and DSO improvements. Electronic Invoice Presentment and Payments (EIPP) solutions also have an outsized impact, especially when they include collection workflow features.
2. Offer Early Payment Incentives
Providing discounts or other incentives for early payment can motivate customers to settle their invoices sooner. For example, offering a 2% discount for payments made within 10 days instead of the standard 30-day terms can encourage prompt payments. Offering a discount, say 10%, to settle an old debt can also be an effective way of reducing your AR balances—the rationale is that it will typically cost you 25% to 33% of the amount collected if you place the account with a collection agency. It’s better to collect a little less now rather than a lot less later, if anything at all.
3. Improve Credit Management
Sometimes the cause of cash flow problems is a liberal credit policy. If that is the case, you need to focus on improving customer credit risk assessment and management. Implement stricter credit approval processes for new customers and then regularly review existing customer creditworthiness. This helps prevent extending credit to high-risk customers who may delay payments, as well as reducing the amount of credit extended, and thereby the open AR balances, of existing accounts who have proven to be slow payers. Credit application processing automation as well as portfolio monitoring and analysis software can help deliver the improvements you seek.
4. Streamline the Order-to-Cash Process
Optimize your O2C process by simplifying order placement, accelerating billing, improving invoice accuracy, and offering flexible payment options. This makes it easier for customers to understand their obligations and settle payments promptly. In addition, getting accurate invoices out quickly to your customers will result in earlier payments by several days and in some cases weeks. Furthermore, invoice errors can cause payment delays ranging from a week to a month.
5. Implement Clear Payment Terms
Ensure that your payment terms are clearly communicated and prominently displayed on all invoices as well as encapsulated in a credit agreement the customer must sign as part of their application process for open terms. This leaves no room for ambiguity and helps customers understand when payments are due. However, it is likely you will need to reinforce your terms with many new customers. You should therefore contact new customers as soon as their initial invoices go past due. If you tolerate slow payments at the beginning of the relationship, it will be harder to get them to change their habits later. If a new customer continues making late payments on relatively small invoices, you may want to revoke their credit and instead require a credit card payment at the point of sale.
6. Enhance Collections Processes
Beefing up you collection efforts is a sure way to improve cash flow. Develop a proactive and efficient collections strategy. This includes regular follow-ups on unpaid invoices, using multiple communication channels, escalating your efforts when payment is not forthcoming despite previous contacts, and potentially outsourcing collections for challenging cases.
7. Offer Multiple Payment Methods
Provide customers with various payment options, including online payments. By accepting credit cards, ACH payments and providing alternative payment rails such as Stripe, PayPal and Venmo, you make it easier for customers to pay on time. Being able to accept payments in multiple currencies also helps if you are exporting. Coupling these payment options with customer self-service features, such as embedded links on e-invoices and collection emails, can give you a competitive advantage over other vendors that are not as easy to do business with.
8. Utilize Data Analytics
Gather and analyze data about your current DSO status and compare it to industry benchmarks. Plotting DSO against monthly sales and total AR balance provides added insight into your performance. You should also incorporate portfolio analysis into you monthly reporting routine, which will help you identify the segments of your customer base where past due balances are accumulating. These insights can help you set realistic goals and identify areas for improvement in your receivables management.
9. Improve Communication Between Departments
Foster cooperation between sales, finance, and customer service departments to ensure a unified approach to managing customer accounts and payments. Too often, collection issues are difficult to resolve due to internal silos. The O2C process impacts and is impacted by various departments within the greater enterprise. Seldom will a problem in one area not impact other areas, not to mention cash flow. In fact, the majority of collection issues are caused by situations created upstream in the O2C process. Collaborative efforts will therefore lead to more effective DSO reduction strategies.
10. Consider Flexible Payment Terms
While it may seem counterintuitive, offering flexible payment terms to certain customers can actually help reduce DSO in the long run. Extended payment periods (e.g., Net 45, 60, or 90 days) to important creditworthy accounts, installment plans for large purchases, and seasonal payment terms for industries with cyclical cash flows are typical options you may want to consider. While flexible terms may initially extend DSO, they can lead to lower DSO over time by building trust and encouraging customers to prioritize payments, allowing customers to better manage their cash flow thereby reducing late payments, and increasing the likelihood of repeat business from satisfied customers. This approach requires careful planning and monitoring but can yield significant benefits for both the business and its customers.
Final Thoughts . . .
Reducing Days Sales Outstanding is a multifaceted challenge that requires a strategic and holistic approach. It involves an ongoing process that requires consistent effort and monitoring to achieve long-term success. By implementing appropriate strategies, businesses can significantly improve their cash flow, strengthen customer relationships, and enhance overall financial health. It's important to recognize, however, that there is no one-size-fits-all solution. Each organization must carefully evaluate its unique circumstances, industry dynamics, and customer base to determine which combination of these strategies will yield the best results.
Ultimately, the key to success lies in consistent execution and ongoing monitoring. Regular review and adjustment of your strategies will ensure they remain effective in the face of changing market conditions and evolving customer needs. By making DSO reduction a priority and embedding AR management best practices into your company's operational DNA, you can create a sustainable competitive advantage, improve the firm’s financial stability, and position your company for long-term growth and success in today's dynamic business environment.