How’s Your DSO Doing?
From Joe Pacor
Hopefully, that’s something you think about often and you realize the answer is not a simple response. That’s because many factors come into play in order to meaningfully answer that question. Days Sales Outstanding is a simple mathematical formula which divides your current outstanding accounts receivable balance by the amount of credit sales, and then multiplies that by the number of days in the period (AR balance/credit sales X # of days in period). This renders a single number, but the qualitative aspects of DSO are what truly underlie the response to the question. Factors that come into play affecting your DSO include: the industry you are in, the terms which you offer your customers, the credit decisions that you make for your customers and the risk you’re willing to take. Once you have a handle on these aspects, you can provide the answer to how your DSO is performing with relative ease. So let’s take a closer look at some of these variables.
Within the apparel industry, terms of 90 days, net due (or more!) are not uncommon. If your DSO were slightly above 90 days, you would be performing exceptionally well. However, if you’re a supplier of perishable products, less than 15 days would be the goal, as payment terms are usually net 10. Clearly, the industry where you conduct your business will greatly influence your metric. Then there are the payment terms to consider. Many businesses offer payment incentives which will reduce their DSO. For instance, 2% 10, net 30 allows for a 2% discount if the payment is made within 10 days. Providing such inducements for early payment will lead to a smaller DSO number. Finally, the credit policy and corporate risk appetite will impact this measurement. Some companies are willing to take on additional risk in order to grow their sales levels…and corresponding DSO. They actually factor in this credit default exposure and budget accordingly (these companies are normally high profit-margin enterprises with quick turnover and significant sales volume). Alternatively, a conservative, restrictive credit policy will limit the amount of outstanding receivables, and thus DSO.
Given the various factors that influence the DSO number, I thought it would also be useful to review the technologies that can improve the metric. Adoption of an integrated credit management solution will help reduce the level of risk and default, as corporate-wide credit exposure can more easily be tracked and managed. Likewise, an invoice dispute management system will support faster resolution of short payments or non-payments due to issues with invoices, such as price and/or shipping discrepancies. Additionally, an automated collections system will help prioritize the management of past due accounts, support a consistent approach to collection strategies, and thus improve the payment process. Lastly, a corporate billing portal with electronic invoicing capabilities will provide convenient access for your customers to review open items and transmit their payments in a timely manner. All of these technologies will enhance your DSO measurement, and thus make it easier for you to respond when asked ‘How’s your DSO doing?’
For more information about the solutions from SAP that help improve DSO, please click here: Receivables Management
Interesting view around different payment terms for different industry sectors.
A way of levelling payment terms differences is to look at terms offered terms taken reports.
If you can collect money before it is due, you are doing well, and if you collect money after it is due you are not doing so well.
One of the biggest benefits that is not normally measured is the effect a common process has on an Accounts Receivables team. Not only does it make team and personal reporting much easier the good behaviours promotes better outcomes. In turm this could lead to head count reduction, or head count optimisation.
DSO by itself is not the greatest measure for an Accounts Receivables team as a growing business will be steadily increasing revenue leading to higher uncollected balances.
Lastly – reporting on P2P’s made provides a good short term incoming cash flow report.
Thanks for that Mark. In a previous life, I was commissioned with driving down working capital in the European division of a multinational. Initially it looked as though Northern Europe was ‘good’ and the Mediterranean belt was ‘poor’. But adopting your approach of benchmarking against the actual payment terms offered, we soon overturned that mis-conception.
Reblogged this on Jamar L. Freeze.
Fully agree with the comment that ‘DSO by itself is not the greatest measure for an AR team’, thus highlighting the importance of all of the other considerations in the article…