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Ultimate Guide for Reducing DSO

Ultimate Guide for Reducing DSO

Ultimate Guide for Reducing DSO

Ultimate Guide for Reducing DSO

You might have heard of the phrase “cash is king”, particularly when it comes to business. Truth be told, a healthy cash flow separates entities that thrive from those that burn out completely. Having a healthy cash flow means that your business won’t have problems paying the bills that keep it going.  

A vital component of a healthy cash flow is great-performing accounts receivables. Measuring how well your business can collect cash payments is critical to ensuring its survival. That’s where days sales outstanding, or DSO, comes in. DSO measures a company’s efficiency at collecting the cash owed to it.      

In this article, we’ll explain the significance of DSO and how you can revamp it to improve your company’s liquidity. After going through this post, you’ll better understand:

  • Why carefully tracking your DSO is beneficial for your company.
  • Why maintaining optimal days sales outstanding is vital for preserving a healthy flow of cash.
  • How you can reduce your company’s day sales outstanding so that nothing holds it back from reaching new heights.

In this article we will be answering:

  • How to Calculate DSO
  • Why is DSO Important?
  • How Do You Reduce DSO?
  • What are the Other Metrics to Analyze Along with the DSO?
  • Using the right tool for your collection process
  • Streamline Your Accounts Receivable Process

How to Calculate DSO

Companies often assess their DSOs monthly, quarterly, and annually. The Days Sales Outstanding formula is as follows:

days sales outstanding formula

To get your company’s DSO for a particular time frame, divide the total value of accounts receivables for a specific period by the total sales within that period. After getting the results, multiply it by the number of days of your chosen period.

Following this simple formula, you can determine how many days on average your company takes to collect payments from customers. 

For example, say Company ABC made a total revenue of $120,000 last month, $80,000 of which were on credit. At the end of the month, the company had $80,000 in accounts receivables. Using the Days sales outstanding formula, we can determine the DSO number in days.

($80,000 / $120,000) * 30 is equal to a DSO of 20 days. 

Company ABC, on average, takes only 20 days to collect payments from customers starting from the sale date.

Now that you have calculated your DSO, you can compare it to this table and evaluate your company’s financial health:

days sales outstanding benchmark for evaluating your DSO

Why Is DSO Important?

A company’s DSO is an indicator of the quality of its cash flow. The lower the DSO number, the less time it takes for cold hard cash to get back into company hands. 

Because cash fuels operations, the importance of maintaining a low DSO is a no-brainer. A high DSO number reveals a payment collection performance issue. If a company isn’t receiving its cash on time, it won’t maintain a healthy cash flow. 

Actively keeping track of your Days Sales Outstanding provides numerous benefits, including a clear snapshot of your company’s overall performance.

1. DSO Tracks Performance

Your DSO can give you a good glimpse of how well your company performs in many of its critical aspects. A low DSO hints at many positive performance signals, including:  

  • A sound collection process
  • A proactive A/R management team 
  • An effective A/R strategy
  • High customer satisfaction
  • Lower risk of cash burnout
  • Healthy overall cash flow

2.  DSO Reveals Cash Flow Issues

If you notice that your firm’s DSO has been on the rise, period-over-period, it could be a tell-tale sign of an upcoming cash crunch. A company must keep paying its bills, ideally on time. A poor cash flow may result in your company failing to meet its obligations, let alone pay expenses. Your DSO can help you keep tabs on your cash flow performance, allowing you to remain proactive.

3. DSO Resolves Problems Before They Grow

If you’ve dealt with accounts receivables before, you’ve probably seen firsthand how crucial it is to convert those receivables to cash as quickly as possible. Keeping a close eye on your DSO means that you can spot issues as they arise and make the necessary efforts to mitigate them. DSO is often analyzed in trends. If you’re noticing a steady increase, it may be time to bolster your A/R management. Resolving your cash flow problems before they become big is vital if you want your business to stay afloat.

4. DSO Can Measure Customer Satisfaction

Your efficiency at closing out transactions on credit can be a direct reflection of how happy your customers are with your products or services. A low DSO might indicate, to a degree, a high customer satisfaction rate. If your customers are happy with the value you bring, they’ll be more likely to pay on time. 

How Do You Reduce DSO?

How to reduce Days Sales Outstanding

Improving your company’s DSO not only involves your credit and collection or accounting departments. It’s going to be a company-wide effort. Generally, a DSO below 45 is considered to be suitable for most companies. However, this benchmark may vary between different industries. 

We’ll walk you through how you can reduce your Days Sales Outstanding so you’ll always have enough cash to fuel your business.

1. Get Your Invoicing Right

The efficiency of your accounting process plays a vital role in your DSO performance. Flawed invoicing can harm your payment collection efforts. Your accounts department should have a laser focus on creating an exemplary streamlined invoicing process to save you from dreaded delays.  

Getting your invoicing right means ensuring that every invoice going out contains all necessary information and is free from errors. You also want to ensure that everything on it is easy to digest since confusion can delay payments. There’s a lot of things that could go wrong with misinformation. Incorrect charges and discounts can turn customers off, or worse.

On-time invoice deliveries can also go a long way in avoiding delays. You don’t want to suffer a setback just because an invoice didn’t make it out on time. Just make sure that you’re mailing to the correct address.

2. Evaluate Your Customers

Your company’s credit policy dictates the terms that customers can repay their balance. One of the benefits of having a lenient credit policy is that you can encourage more sales. However, if a reasonable collection rate is what you’ll have to give up for having better sales, you might want to rethink your strategy.

The best way to evaluate your customers is to set up ideal criteria for an acceptable customer risk. Based on these criteria, you can determine if a new customer presents a chance of being a problematic payer. You can also apply these criteria to existing customers, particularly those who are slow in making payments. 

After perfecting your credit terms, make sure that your sales team follows them by the book. Some of your salespeople might not be too keen on losing out on sales, even if it meant dealing with risky customers. To combat this natural tendency, you can implement specific consequences for breaking the rules.

3. Make It Easier For Customers to Pay You

You want to make customers feel special, but having a track record of satisfied customers isn’t enough to keep your business healthy. One of the best things that you can do to reduce DSO is to make it easier for customers to pay. Offering flexible payment methods such as credit card payments can make it convenient for customers to pay.

Communication is key when it comes to transactions that involve credit. Keeping contacts open can strengthen your relationships with your customers and encourage them to pay on time. You can take communication a step further by providing your customers with options to view their statements and invoices online.

4. Bolster Your Accounts Receivable Management Strategy

Making a sale isn’t the end of the story. After sending out an invoice, you’d want to ensure it doesn’t remain unpaid too long. An effective A/R management strategy can help you keep tabs on every outstanding balance and take the necessary steps to collect them.

Focus on having a good follow-up plan in place whenever customers get late on their payments. As with many other facets of your business, communication is vital in managing accounts receivables. Apart from getting in touch with slow-paying customers and settling disputes, it would help if you also encourage them to communicate their problems. Doing so allows you to determine if their situation is eligible for special payment arrangements. Providing a unique payment plan may not be ideal, but it’s better than dealing with a prolonged payment default.

All of this process can also get automated so that the finance teams no longer need to worry about unpaid invoices and costly errors.

If worse comes to worst, having a straightforward guideline can save you from a lot of headaches. For example, you might include a policy for turning over a delinquent account to a collection agency. 

5. Incentivize

Providing incentives for early settlements prove that you value your customers. It could also motivate your customers to pay earlier than they normally do. Incentives can take the form of early payment discounts or just downright slashing off your prices right off the bat for repeat customers. 

For example, you could offer a discount when a customer pays within 15 days for a 1-month payment term. If you think it may not be worth it, think about how the early incoming cash could help pay off some of your expenses. 

What are the Other Metrics to Analyze Along with the DSO?

While DSO calculations help optimize A/R, they still leave room for assumptions. That’s why it’s best to consider other factors for a clear picture. Besides, these factors help the senior management detect error-prone areas and formulate an action plan to eliminate them.

Other metrics to measure with Days Sales Outstanding

1. Collections Effectiveness Index (CEI)

As the name suggests, CEI measures how effective the collections team and their procedures are. Acknowledged as one of the best metrics to consider along with DSO, you can interpret the order-to-cash teams’ performance.

2. Bad Debt to Sales

Bad debt occurs when customers can’t pay their dues, and this metric shows how much is written off. This is measured in ratio, and if it increases with time, it suggests weak credit policies and management.

3. Days Deduction Outstanding

DDO or Days Deduction Outstanding is a metric calculated to clarify how a business deals with its deductions. DDO is calculated by dividing the outstanding deductions by the average deductions in a certain period. The period could be three, six, or 12 months.

4. Accounts Receivable Turnover Ratio

A crucial metric to gauge how a business manages and collects its assets. We recommend aiming for a high A/R turnover ratio as it indicates process efficiency.

5. Best Possible Days Sales Outstanding

This metric defines the best possible number of days it takes for a business to collect its receivables. It’s theoretically calculated for an internal comparison between the DSO and BPDSO. Based on this, the senior management establishes the best method for benchmarking AR.

Use the Right Tool For Your Collection Process

It’s almost impossible to reduce DSO with having slow manual processes in place. 

Every component of your business should have a sound process in place, and your collections are no different. The systems you employ when collecting money owed will determine how well you can improve cash flow. 

Apart from providing the proper training, equip your teams with the right tools to improve their collection performance. Opting for a full-service accounts receivable software can streamline your collection processes from invoices to cash receipts.

miscommunication and lack of alignment among departments

A great platform can provide all the tools you need, from workflow automation to integrated payments to customer portals. The added automation adds convenience and flexibility for both your team and customers. 

Getting exceptional accounts receivable software not only aids you in reducing DSO. Ultimately, it saves you time, money, and resources by allowing you to work smarter and faster.

Summary

Growing a business takes a lot of hard work. To guarantee your business’ growth, you must focus on one of its most essential drivers — cash flow. Properly managing your cash flow can ensure that it stays on the right track. 

Reducing DSO is one of the most effective approaches to improving your business’s finances. Though it may seem complex at first, improving your DSO takes only a few key steps. By facilitating teamwork and implementing the right tools, you’ll ensure good results coming your way.

Streamline Your Accounts Receivable Processes

Peakflo allows you to streamline all of your accounts and collection processes under one high-performing digital platform. We offer features that help you increase your A/R team’s productivity and make it easier for customers to pay you on time.  

Big or small, we’ll provide you with a complete picture of your company’s finance.

Connect your accounting software with Peakflo today and start automating your accounts receivables!

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Reach Your Customers With Automated Whatsapp Messages

Why you should add WhatsApp to your invoice collections toolkit

Whatsapp Banner When you are  a growing business, one of your most important priorities is getting paid fast so that you can reinvest into the business. The thing is: getting paid is hard and chasing invoices is harder. You send email reminder after reminder and no response. This is especially true if your customers are small businesses, who tend to be more responsive on WhatsApp. Peakflo helps you get paid faster by automating customer reminders via a centralized workspace. Now you can automate WhatsApp messages to meet your customers where they are! Don’t think that’s a big deal? Here’s why this is a game changer. 1.You can create  personal connections via  the world’s most popular messaging app According to Statista, 2 billion active users access WhatsApp messenger on a monthly basis meaning your customers already use the app daily to speak with friends, family and colleagues. WhatsApp is where your customers are. This means they will be more responsive than if you just sent an email. What’s cooler? Using WhatsApp for business, you can allow Peakflo to track and showcase an audit trail of not just the invoice reminders sent to your customers but also their responses. All this gets rolled up in reports as well as your customer’s timeline—a record of the communication history with each customer. 2.You can communicate intricate details effortlessly  For the first time, you can convey the same high fidelity information of automated email reminders inside whatsapp. Peakflo provides customizable templates,allowing you to include specific details, from the outstanding invoice number to the total outstanding amount. workflow custom 3. Your customers can more easily engage with your company and pay their invoices A customer portal link embedded in  every whatsapp reminder allows your customer to view their summary of accounts at any time, view their invoices, ask questions, raise disputes, and conveniently pay any outstanding amount using multiple payment methods including bank transfers, eWallet or card. accounts payable Unleash the power of whatsapp to streamline your AR collections process with Peakflo. Want to learn more about how we can save you time and increase your productivity?
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Why you should be automating your accounts receivable collections

calculator and ledger When a customer buys a product or service on credit from a supplier, the supplier considers it a sale, but because the cash has still not been received it is accounted as accounts receivable. The accounts receivable automation (AR Automation) process means automating the production, sending, and collection of invoices. AR Automation involves using software, often with artificial intelligence and machine learning technology, to streamline the AR collections process. AR automation is a part of order-to-cash process automation process which involves:
    1. Order Management
    2. Credit Management
    3. Order Fulfillment
    4. Order Shipping
    5. Customer Invoicing
    6. Accounts Receivable
    7. Payment Collection
    8. Reporting and Data Management 
AR automation can automate processes from customer invoicing to reporting and data management.

Key Challenges in the AR Collections Process

High Transaction Volumes  If a company is doing well, there will be hundreds, if not thousands, of transactions which need to be handled by the accounts receivable department. If all the tasks are handled manually, then the turnaround time (TAT) would be incredibly slow. Inefficient Collection Process Manually processing accounts receivable occupies resources with the mundane activity of generating and emailing invoices. Because reps will have insufficient time to cater to each and every query, the collections rate will suffer and bad debt will accrue. Also, if there are no pre-generated collections processes set for collection activity, each collector will do their own thing leading to variability and human error. Inconsistent Credit Assessments If the process of credit assessments is manual, then the selection might be subjective–giving unqualified customers higher limits than those who may have been more qualified.  Alternatively, companies sometimes lose track of who has which credit limits because of disorganization in the account records. This increases the risk of bad debt. Reporting Errors   In the manual AR collections process, it may happen that the employees are working in different systems e.g. tracking customer data using excel, following-up using outlook, issuing invoices using ERP.  Due to the manual nature of the process and working across the three different systems, it might happen that the employee might miss some data for reporting, this may lead to serious reporting errors. Almost all the above problems can be solved by AR automation as it follows a single process, is fast and precise, and all the data can be found in one place.

Key Benefits of AR Automation

Frees Up Employees To Do High Value Work Manual accounts the receivable process is too cumbersome and very costly, as it requires dedicated employees to work full time in trivial tasks of producing and sending or uploading the invoices, AR automation process will free up the employees from such mundane tasks and those employees can be allocated to some higher value task. Environmentally Friendly AR automation can also reduce the cost of manual printing and stationery, it can auto generate invoices and the system can email invoices to customers and hence save a lot of costs. Reduces Human Error AR automation removes humans from the equation, eliminating human error, improving data consistency with real-time responsiveness. The result? AR automation increases accuracy and reduces the likelihood of a customer dispute. Credit Tracking  AR automation can better manage credit assessments and track outstanding credit limits helping keep money in the company. Centralized Workspace For All AR In AR automation, every document and data can be found in a single place, so the chances of reporting errors are extremely low.

Who AR automation benefits

AR automation benefits almost all the industries, however, there are some industries where the implementation is higher.  For example, the banking and financial services space see a huge transaction volume. Similarly, industries with high transactions would see huge benefit in automation. Below examples of industries where the AR automation would be a gamechanger:
  • Banking, Financial Services, and Insurance
  • Telecom and  Information Technology (IT)
  • Manufacturing
  • Wholesale Distribution and Logistics
  • Food and Beverage
  • Retail
AR automation if implemented smartly will help immensely in cutting the cost, streamlining the process, companies have better working capital cycle, stable cash flows and can have fewer bad debts. As the process recently is widely accepted by the industry, it is imperative for a company to implement AR automation for its success. Want to learn how Peakflo tackles AR automation?
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Why Accounts Receivable Management is the Most Underrated Lever for Business Growth

Why Accounts Receivable Management is the Most Underrated Lever for Business Growth

It’s not uncommon to find businesses without a proper accounts receivable management system. The problem? AR management is undervalued and as a result businesses often make the mistake of having no AR management at all or using outdated tech.

dashboard on computer screen

What Does it Mean to Manage Accounts Receivable

Accounts receivable (AR) is the lifeline of a working capital management system for any business. Managing AR means having in place a system, policies, and procedures to streamline the accounts receivable.

We all have heard that liquidity often proves more critical for a business than profitability. Accounts receivable directly impact a business’s liquidity. Yet, we see so many businesses undermining AR as a key metric for business growth.

An effective accounts receivable management system means:

  • Having in place effective policies and procedures
  • Using the right technology for AR management
  • Having a systematic approach towards collections
  • Creating a strategy for delinquencies
  • Communicating effectively within the organization and with the clients

Common Mistakes Companies Make When Managing Accounts Receivable

There are some common pitfalls that most businesses fall into when it comes to managing accounts receivable e.g ignoring the AR management or deferring it until it becomes a nuisance.

Let’s look at the five most common errors:

Mistake #1: No AR Policy

Accounts receivable management  is not a one-time task–it requires constant maintenance and intentionality. Despite this, many businesses do not articulate a formal AR policy. That means companies have no internal controls and unexplained procedures.

Mistake #2: Inefficient Technology

Going digital for modern businesses has become inevitable. However many companies are still using excel to manage their AR. Some companies use accounting software to gain cash flow visibility, but lack a way to properly manage invoices.

Mistake #3: Ineffective Communication

Another grave mistake firms make is that they fail to communicate clearly with both internal stakeholders and clients. This leads to uncertainty about what actions have been taken on which accounts and confuses the client. This chaos results in inefficient cash collections and bad customer service.

Mistake #4: Extending Credit to Unqualified Customers

A common mistake made by many businesses is to extend the credit facility to unqualified customers. Why? They don’t know which customers are qualified because they lack data insights and visibility into client behavior. This not only affects the liquidity of the business, it deprives the qualified clients as well.

Mistake #5: Inaccurate Records

A lack of technology and proper tools leads to errors and omissions on invoices. These inaccuracies lead to customer disputes and constant back and forths that drag on the cash collection period.

Optimizing the Most Underrated Lever of Business Growth – Accounts Receivable

Optimizing the accounts receivable management revolves around two key aspects for any business.

  1. Create An Accounts Receivable Policy

Formulating a formal AR policy will lead to clarity as you put in place effective internal controls and procedures. A clear policy means your business stays proactive with cash collection and client relationship management.

  1. Technology

Businesses are often reluctant to invest in AR management systems because they fail to see the value of having both an accounting software and an AR management system. However, acquiring the right technology can improve revenues, reduce reliance on debts, and accelerate cash collection. It also makes life easier for your Account Owners.

Best Practices for Managing Accounts Receivable

Strategizing the accounts receivable management is the first step towards success. An effective action plan and best practices can ensure your accounts receivable management stays on top. 

Here are six best practices for managing accounts receivable.

  1. Automate, Automate, Automate

Start using accounting and invoice software. Automate your invoices and billing reminders to your clients. Automation will speed up your cash collection, reduce errors, and improve client relationships.

  1. Prioritize Credit Policy

Set up a clear credit policy. Do not extend the credit terms to unqualified clients just to increase sales because it will bite you in the long run. You also want to track credit limits and client credit behavior.

  1. Accept Electronic Payments

Make it easy for clients to pay.  If you can, start accepting invoices electronically. This removes any payment friction and helps you collect faster. 

  1. Improve Communication

Engage your AR staff regularly on set policies and procedures to make sure your policies still make sense and that everyone understands what they are. Also, make sure your clients are getting the right information from your business. Clients should be able to reach you easily to ask questions, raise concerns, and understand their balances.

  1. Track the KPIs

A pivotal task for AR staff is to use the right Key Performance Indicators (KPIs).

  • Days in Sales Outstanding
  • Average Receivable Days
  • Cash Conversion Cycle
  • Days in Delinquency
  • Collection Effectiveness Index

Learn more about key metrics here : (Link to AR article)

  1.  Outsource Delinquent Account Collections

It’s inevitable to find delinquent accounts in accounts receivable for many businesses. At this stage, it’s wise to outsource the invoices to collection agencies that specialize in the task.

How Peakflo Can Help

Realizing the importance of AR management is the first step in the right direction. You can then formulate a comprehensive AR policy and set procedures accordingly.

You may need to arrange the right tools for your AR department. It’s worth investing in a system that will keep your cash flows flowing.

Peakflo increases transparency, giving you full visibility into your accounts receivable status. The comprehensive tool streamlines collections by:

  • Automating payment reminder with workflows
  • Providing credit limit overviews with the Credit Control Report
  • Enabling customer electronic payments with the Customer Portal
  • Tracking relevant metrics on our dashboard
  • Pursuing delinquent accounts by issuing Letters of Demand on your behalf

 

Sound interesting?

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