As a financial decision-maker, everything comes down to one thing: how does this impact your company’s cash flow? There are countless strategies you can implement – some more innovative than others – but it’s important not to overlook the basics. Improving your days sales outstanding (DSOs) is a simple way to optimize your finances, helping you secure what you are owed so that you can invest the profits back into your business.
How do Your DSOs Measure Up?
According to a Euler Hermes study of 27,000 companies around the world, the average DSO was 64 days. One out of every four companies waited 88 days or longer, with 9 percent of all respondents reporting an average DSO of 120 days or more.
That said, the Euler Hermes study spanned companies across 20 different sectors, and there tend to be significant variations across different industries. (This calculator allows you to compare your average collection period to the average for your industry sector, with benchmarks for construction, manufacturing, wholesale and retail trade, transportation, professional services, and other unique verticals.)
There are also company-specific factors that can influence your DSOs (and how they measure up to others in your industry). For instance, seasonal sales trends can understate (or overstate) the actual status of your accounts receivable department. During the slow season, you may have fewer invoices to process, and one or two unusually late payments can significantly skew your average. Comparing your company’s performance on a quarterly basis – and comparing it to the performance of the same quarter from the previous year, rather than the performance of the last chronological quarter – can provide you with more accurate insight.
You’ll also want to consider how your specific payment terms influence your customers’ payment habits. If your average DSO is significantly higher than your standard terms, you may want to think about re-evaluating your collection process or underwriting procedures.
Five ways to improve
So you’ve benchmarked your performance, and your DSOs are higher than they should be. What now?
Consider updating your payment terms. Your payment terms set the bar for your customers’ payment procedures. While you have to account for your industry’s specific practices and your customers’ expectations, you may need to make your terms more company-friendly to improve your DSOs.
Offering your customers early payment discounts for paying their invoices within 10 or 15 days is one common incentive to consider. Another option is making it easier for customers to do business with you by offering more convenient payment options. Even if most of your customers still use paper checks, accepting credit cards and electronic payments can make your organization more flexible in an increasingly digital world.
Re-think your credit decisions. Customers that have cash flow issues of their own aren’t well-positioned to pay their invoices on time. Do you have too many of these organizations making up your customer base? If so, there’s a potential reason for your high DSOs.
Of course, there’s a delicate balance to strike here: become too strict, and you’re missing out on potential business. Become too lenient, and you’re taking on unnecessary risks.
Deloitte offers several actionable recommendations for re-evaluating your credit policies. One key takeaway? Get input from your sales team. They’ll be able to help you determine what the current market looks like, when you might benefit from overriding your credit limits, and when you might need to put a customer’s account on hold.
Also, if you’re not performing credit evaluations for each new customer, that’s another easy change to implement. Internally, set a deadline for approving or rejecting each application. (One to two days is reasonable, especially if you’re using a company that runs electronic evaluations.)
Improve your invoicing practices. Invoicing is one of the most critical steps in the order to cash cycle. While others steps can be completed concurrently, you can’t move on with the rest of the process until an invoice has been paid.
One way to improve in this regard: reduce the amount of time it takes to send out an invoice after an order is processed. Automated invoicing solutions can make it so your employees don’t have to manually create each invoice, significantly speeding up the process. Plus, you won’t have to deal with data entry mistakes and disputes. Customers can pay their invoices right away, instead of having to contact you to get quantities adjusted or discounts applied.
Also important: are your invoices clear and easy to understand? If they don’t clearly display your payment terms, due dates, and address, it’s time for a new template that puts this information front and center. Most companies already have a hard time keeping up with their accounts payable – anything you can do to make their life easier can increase your chances of getting paid more quickly.
Develop a better action plan for following up on unpaid invoices. It’s a frustrating reality, but there will always be a percentage of customers that don’t pay their invoices (either on time, or at all.) Having a clear action plan can help you deal with these situations faster and more efficiently.
Your first few communications should be helpful and polite. Late payments happen, and they’re not always intentional. A simple follow-up is often enough to prompt a payment while keeping your working relationship on good terms.
If your first attempt (or even a second attempt) at a friendly reminder doesn’t get the desired result, you can gradually escalate your communications. (Here’s a helpful roadmap for internally dealing with unpaid invoices before getting a collections agency involved.)
Set goals that promote long-term adherence with your new policies. Even the best intentions won’t make an impact without follow-through. Once you’ve developed a strategy for reducing your DSOs, you’ll need to sustain those efforts in the long term. Be prepared to make administrative policy changes and communicate their importance to each of the departments that will need to update their procedures.
One strategy for keeping everyone on board: getting buy-in at the very beginning of the process, before any decisions are made. It’s easier to get your credit managers, accounts receivable processors, and collections managers to permanently shift their approach when they’re involved with the changes from the start. Building – and then sustaining – this momentum can help you produce the meaningful changes you need to increase profitability and improve your cash flow year over year.
Faith Kubicki is the Content Marketing Manager at IntelliChief.