What is days sales outstanding (DSO)?
Days sales outstanding (DSO) is an accounting ratio that measures the average number of days it takes for your company to collect payment on a sale. Well-managed cash flow is vital for a healthy business, and days sales outstanding is one part of your cash flow equation. By learning how to improve days sales outstanding, you can strengthen your company's financial health.
The average DSO varies by industry. A high DSO indicates that payments are delayed and could signal a cash flow problem, whereas a low DSO suggests that you're getting timely payments. Discover six steps you can take to decrease your days sales outstanding using your digital collections software and how improvements benefit your business.
Why is reducing days sales outstanding (DSO) important?
Quick and predictable repayments keep your cash flow balanced. However, past-due accounts can overshadow a stellar month of sales. Each overdue amount decreases funds available to buy inventory, pay employees, and cover operational expenses. And if an emergency strikes, inadequate cash flow can hamper your ability to recover.
Debt collection issues also hamper your ability to expand your company. According to an Intuit QuickBooks survey, 89% of "businesses said that late customer payments have set back their company's long-term growth goals." Reducing days sales outstanding means more cash on hand and less financial stress.
The top advantages of lowering your DSO include:
- Access funding: If you want a business loan or are looking for capital investors, cash flow improvements from reducing DSO may improve your odds. Financial lenders and investors may consider your DSO when determining your credit worthiness.
- Contingency planning: Whether it's a market downturn, a sharp increase in operating expenses, or an emergency, a lower DSO means more cash on hand, enabling you to weather the storm, literally or figuratively.
- Decrease third-party collections: Companies with higher DSO may need more assistance collecting past-due accounts or risk write-offs. Reducing days sales outstanding can lower your reliance on third-party services.
- Cover expenses: If your payments are frequently late, you may only have enough funds to cover bills for a month or possibly less. Increasing the cash on hand to cover day-to-day operational costs and expenses contributes to your financial health.
6 steps to improving DSO with digital collections software
There are several ways to address a high days sales outstanding ratio, but each can be time-consuming, especially if you use manual processes. Intuit QuickBooks found that 65% of businesses spend "14 hours per week on average completing administrative tasks related to collecting payments." Payment collections software optimizes your efforts, allowing you to improve DSO without increasing your staff. Here's how to improve days sales outstanding by incorporating digital collections software into your process.
Step 1: Integrate your collection software into your accounts receivable system.
Integrations are crucial to your debt management and collections system. By syncing your accounting platform to your digital collections software, you can automate several steps of your early-stage collections process. Integrated tools also let you quickly pull data from your reports to prioritize accounts.
However, the integration process varies. Therefore, it's essential to talk to your digital collections software provider to ensure that your A/R tools will integrate and determine how long the process will take. In some cases, your software vendor will help connect your existing programs, including a secure payment gateway. Before selecting your system, explore these collections and recovery software tips.
Step 2: Calculate your DSO for last month.
Use balance sheet reports from the first and last day of the month to determine your average accounts receivable. Add your beginning and ending balances together and divide by two. The total is your average accounts receivable for the month. Next, compute your total credit sales, and don't forget to subtract any returns from them.
Now that you have this information, you can put it into the DSO formula:
(Average Accounts Receivable / Credit Sales) x Number of Days in the Month = Average Days Sales Outstanding (DSO)
Step 3: Identify the top 10% of your past-due accounts.
Use your accounting and digital collections software to determine the top 10% of overdue accounts and focus your attention on these first. Specifically, look for customers in the early stages of the collection process. According to a Lexop survey, 22% of customers didn't pay simply because they forgot. This suggests that actions like sending an email or SMS message could alert them to their past-due amount and encourage them to remit payment quickly.
Step 4: Use the software to create a plan to contact each of these customers.
Build humane debt collection best practices into your strategy and use your tools to create a seamless repayment journey. Your digital collections software should provide templates for outreach and allow you to monitor how and when customers interact with your messages. In the early stages, the best channels for debt collecting are often digital. Indeed, 69% of Lexop survey respondents prefer to be contacted by email or text message.
Your past-due customer path may include email, text messages, and an online self-service portal. You can use analytics to determine how effective your methods are and tailor your approach to different customers.
Step 5: Incorporate this communication plan into your existing workflow.
A new communications plan should complement your current workflow and align with your digital collections strategy. It shouldn't feel forced or require your staff to learn an entirely new routine. Instead, your payment collections process and tools should be convenient for your team and customers. A well-planned digital collections strategy strengthens your existing process by reducing complexity.
Step 6: Track results and adjust as needed.
Develop insights into past-due customer behavior using digital collections software with analytics and data reporting tools. It can provide details about which messages and channels received the best response rate and reveal information about your customers' preferred payment methods. Use this data, your collection metrics, and key performance indicators (KPIs) to track goal progress and modify your outreach efforts accordingly.
Take action to improve your days sales outstanding
When it comes to improving days sales outstanding, digital collections software can help you collect more and faster. Lexop gives you everything you need to reach, incentivize, and collect from your past-due customers. By leveraging early-stage collection tools, you can reduce your DSO and strengthen your company's financial health. Talk with an expert to learn how to optimize your collection strategy.