Working Capital

Metric of the Month: Days Sales Outstanding Measures Efficiency

Collections are key to a low days sales outstanding (DSO) number — and the faster the money comes in, the more breathing room an organization has.
Perry D. WigginsMay 9, 2018
Metric of the Month: Days Sales Outstanding Measures Efficiency

Days sales outstanding is a key measure of a finance team’s efficiency and is closely linked to days cash on hand and liquidity. Every organization is happy to have sales, but closing sales isn’t enough to keep a business afloat. Collections are key — and the faster the money comes in, the more breathing room an organization has.

For this month’s metric, we look at days sales outstanding as reported to APQC’s Accounts Receivable Open Standards Benchmarking survey by 5,204 survey participants in various industries. DSO is defined as:

Accounts Receivables ÷ (Net Sales ÷ 365 Calendar Days)

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The fastest collectors are the top performers. They get paid in 30 days or less on average. The bottom performers take 48 days or longer to collect on their invoices, on average. At the median, companies need about 36 days to close the AR cycle.

Days Sales Outstanding

graphic of DSO

However, keep in mind that a “good DSO” number in one industry may be a disaster in another.

When I worked in healthcare, for example, payment was subject to reimbursement by insurance companies, so 40 days or less was considered an excellent DSO. In manufacturing, a DSO of less than 30 days is the norm.

The best way to know how your DSO stacks up to others in your industry is to benchmark DSO against your peer organizations.

Breathe In, Breathe Out

Cash is like oxygen for any organization. It’s a lot like SCUBA diving: When you’re exploring a shipwreck at the bottom of the ocean, your life depends on knowing exactly how many minutes of oxygen you have left before you need to get back up to the surface.

DSO is like the air in your tank: You need to fill it with more oxygen than you’ll use up in a given time period, or you’ll drown.

But a word of caution: When sales are going great, it’s easy to become overconfident and spend money the organization hasn’t yet collected. If it takes too long to collect, you could deplete your oxygen too soon and find yourself desperate for air.

In an ideal world, every business would collect payment faster than it needs to pay its payables. But in the real world, that’s much easier said than done.

Of course, one effective way to collect payment is to have a dedicated team calling customers and reminding them to pay their outstanding invoices.

However, many small organizations don’t have the budget for a full-time credit and collections department. Working open invoices tends to fall on whichever finance team member can fit in the extra time. Making collections a day-to-day job keeps the pressure on customers to pay late bills, which increases cash flow.

Another factor to consider is whether the organization is collecting on its customer’s terms, or on its own terms. Is it giving customers 60 days to pay, while competitors insist on net 30? If so, does giving extra time encourage customers to buy more, and is it worth taking a hit to working capital to float some customers credit for an extra month?

For high-volume, dependable customers, the answer may be yes — or it may make more sense to take that relationship to the next level. For key strategic partners, an organization may be able to work out an automated payment system that seamlessly facilitates movement of product or services and cash back and forth, without paperwork delays.

For fixed-fee service work, establishing a payment schedule based on estimates can help both sides better predict and control cash flow.

Payment Hold-Ups

It’s also wise to break down and address the various reasons that customers pay late.

Delays are not always due to a customer not having the cash on hand. Are there quality issues with a product or service that are in dispute? Is paperwork missing or incomplete? Has the customer switched to new supply chain management software that requires additional detail that the seller’s invoices don’t have? Is it possible that the customer is using any or all of these factors to delay payment and keep that cash in hand a little longer?

A little digging may reveal that payment for services is being held up by missing receipts or errors related to expense reimbursement. A simple fix is to send two separate invoices: One for expenses and another for time and materials.

That way, the customer won’t have any reason not to pay for services, even if the expense issues take a little extra time to resolve.

In a world where cash is essential, every day that cash is in someone else’s hands is a day that an organization could be breathing a little easier if it were in its own hands. Taking time to evaluate and improve collections processes can reduce DSO, and means more money in the bank and less time spent underwater.

Perry D. Wiggins, CPA, is CFO, secretary, and treasurer for APQC, a nonprofit benchmarking and best practices research organization based in Houston, Texas.
Image: Thinkstock