In today’s marketplace, it is very common for a business to extend credit to its customers. Extending credit is a great way to reach a segment of customers that may not have the cash flow to pay the full cost of a product or service upfront. It can be a great way for a business to acquire new customers but it can also hurt your bottom line without realizing it if you aren’t careful.
The old saying is true, cash is king. It is the lifeblood of your business. Without cash, you can’t survive. Therefore, as a small business owner, a key metric you need to track is your Daily Sales Outstanding, or DSO.
What is DSO?
Investopedia defines DSO as, “A measure of the average number of days that a company takes to collect revenue after a sale has been made.”
So, how do you calculate your current Daily Sales Outstanding?
How to calculate Daily Sales Outstanding:
DSO = Accounts Receivable / Total Credit Sales X Days in Period
Let’s take a look at an example to wrap our minds around it more.
Let’s say your company started the month with $1,000 in receivables. Throughout the month you made an additional $500 in credit sales, making the accounts receivable total $1,500. You also had customers pay $400 on previous credit sales. So at the end of the month, the accounts receivables balance totaled $1,100.
If you want to calculate the DSO for the month, you would plug in the numbers as follows:
$1,100 (accounts receivable) / $500 (credit sales for the month) X 31 days = 68.2
DSO is a financial KPI (key performance indicator) that is best tracked over a period of time – typically, month to month. As the business owner, you want to see if the trend in DSO over a time period is moving higher or lower.
Ways to Improve Daily Sales Outstanding
1 – Send Invoices Quickly
The easiest way to reduce DSO is to invoice customers as soon as the purchase is made. The longer it takes for a customer to receive an invoice, the longer it will take to receive cash.
2 – Offer Discounts
Another great way to decrease DSO is by extending discounts to customers if they pay within a certain time frame. Typically net/10 with a percentage discount. This tells the customer that if they pay within 10 days of receiving the invoice, they will receive a discount equal to the percentage amount offered.
3 – Get Rid Of Bad Customers
Getting rid of bad customers can be difficult to do but it can save your business’s cash flow. If your average DSO is 31 days and you have a customer that typically pays 60 days after invoicing, it is time to let them go. The key to the decision to fire bad customers is a matter of costing, which your bookkeeper can help you determine.
Every activity your firm engages in has a cost, and hopefully, these activities average out to be more profitable than costly. Extra collections activities, second and third invoices, and the lost use of the cash can be calculated so you can determine whether or not a customer is really worth keeping around.
Conclusion
Determining your company’s Daily Sales Outstanding is a critical factor in understanding your business’s cash flow. Knowing how long on average it will take to receive funds provides you with insight on whether or not you have enough cash to cover basic expenses. If you can find ways to reduce your DSO, you can absolutely increase your business’s cash flow, but this can be a challenge for many business owners.
If you are interested in calculating your company’s DSO but aren’t sure where to start, Still Water Financial Operations can help. Our team of bookkeeping professionals and fractional CFOs can help you find your DSO and then identify ways to lower it to help you make more money, faster.
Fill out a contact form to schedule a free consultation with one of our team members today!