Most chief financial officers would say building up cash on the balance sheet is important. But one way to do that — converting sales into cash faster — sometimes gets forgotten. One reason: over the past few years, low interest rates made using debt to boost liquidity less expensive. That resulted in less emphasis on working capital management; in particular, the efficient management of accounts receivable (AR).
Now that the Federal Reserve is increasing the Fed funds rate, though, and interest rates are heading north, some finance departments will turn their focus to the timing of cash flows. In the AR function, that means keeping a tight rein on customers to get them to remit payments within the agreed-on term, as well as tracking down and collecting overdue payments.
The metric finance executives will be trying to lower is days sales outstanding (DSO) — the time it takes to collect payment for a sale. This is much easier said than done. DSO deteriorated (or increased) in 2019 and 2020, according to the annual CFO/The Hackett Group Working Capital Scorecard, as customers delayed payments to beef up their own cash cushions.
But in 2021, according to the Hackett Group scorecard, the trend reversed for more than half of the largest 1,000 U.S. companies. (See CFOs Hunt for More Cash: 2022 Working Capital Scorecard for the full results released last week.) Overall, DSO dropped by 1.1 last year, to 40.6 days. (The equation to calculate DSO is year-end trade receivables net of allowance for doubtful accounts, divided by one day of revenue.)
Many factors contributed to faster payments. A 22% gain in revenue among the 1,000 companies helped, as did the DSO increase in 2020. During the pandemic in 2020, some suppliers were persuaded to temporarily stretch credit terms for buyers, if they themselves could handle the slower inflows. In 2021, however, suppliers looked to return to selling on more standard payment terms, said Shawn Townsend, a director at the Hackett Group.
Through an industry lens, improvements to DSO were widespread but not uniform. The rapid economic rebound in the United States that fueled strong consumer demand helped industries like airlines, recreational products, and hotels and restaurants produce healthy reductions in DSO. (See chart, “A Better Job Managing Receivables.”) But some industries, such as semiconductors and equipment and containers and packaging, had to wait a little longer for buyers to pay their invoices.
Of the 49 industries listed in the chart Hackett analyzed for 2021, 32 improved DSO and 17 saw a deterioration in DSO (however slight). Traditional payment terms varied across industries, of course. As is evident in the chart, normal terms in aerospace and defense (more than two months), for example, wouldn’t fly in the food industry (less than 30 days). In fact, only 20 industries had a DSO lower than the overall measure of 40.6 days. The median DSO for the 1,000 companies was higher — 48.7 days.
For benchmarking purposes, it can be helpful to know how your company’s industry performed, but be aware that there were also wide variations within industries. In the beverages industry, for example, Boston Beer lowered DSO to 10 days from 16, while Monster Beverage’s DSO rose to 59 days from 53.
Also worth noting is that most of the industries that collected on invoices faster did not pass on their good fortune to their suppliers. In the top 10 industries that improved DSO the most (the first 10 industries listed on the chart), only three paid their trade creditors faster — recreational products, general and specialty retail, and automotive parts and aftermarket.
The Hackett Group Working Capital Survey and Scorecard calculates working capital performance based on the latest publicly available annual financial statements of the 1,000 largest nonfinancial companies with headquarters in the United States, sourced from FactSet/FactSet Fundamentals.