Maintaining healthy cash flow and proper working capital levels is a constant struggle for most businesses. If you’re having issues, it may be worth looking at two key metrics that may indicate where your problems lie.
DSO, or Days Sales Outstanding measures the average number of days that it takes your customers to pay their invoices. A high number indicates slow payment, which can delay cash from hitting your account. Lowering your DSO will translate to stronger cash flow.
The other metric to look at is your DPO, or Days Payable Outstanding. This is the flipside to DSO. It represents the average number of days that it takes your company to pay vendors, bills, and other outstanding invoices. With DPO, higher numbers are better as this translates to cash-in-hand for longer periods of time. If your DPO is too low it means that you’re paying invoices too quickly, placing unnecessary limitations on working capital.
Below you’ll find a number of strategies to reduce DSO and improve the ratio of DSO to DPO in order to heal cash flow problems.
Before you take any other steps, it’s important to have a full and complete picture of your receivables and payables. For DSO, make sure you have reporting practices in place that allow you to see which customers tend to pay late, trace any correlations that exist with your sales practices, and discover internal issues that might be causing delays.
For DPO, you need to know how much you’re spending, on what, by whom and the terms that were negotiated. Increasing visibility on both of these metrics will help guide your improvement efforts.
Adjust Your Payment Terms
A good rule of thumb is that your DSO should be within 20% of your stated payment terms. If you’re within the right range and find that your DSO is too long you should consider gradually reducing your payment period. If you find that the percentage is significantly higher than it should be it’s worth offering incentives and/or charging penalties to motivate a closer alignment.
You could offer an early payment discount if your customers pay within 10 or 15 days. On the flip side, you could charge a small penalty for payments that are made after your normal payment window. These penalties could accrue at regular intervals after an invoice’s due date passes.
Automate Your Billing
If you’re still relying on manual, paper-based billing systems, you should consider going digital. Electronic invoices can be generated and submitted for payment considerably faster, arriving in your customer’s inbox immediately.
These systems will keep you apprised of outstanding invoices, send out automatic payment reminders, and can make it much easier for customers to pay. In many cases, you can have direct links to digital payment methods included right inside your invoice.
It’s also worth offering your customers a wide range of payment options. Depending on their current financial situation, certain payment methods might be more desirable than others. Meeting your customers where they are will help speed collections and reduce your DSO.
Reexamine Vendor Terms
It’s often possible to negotiate better payment terms with your vendors and other accounts payable, particularly if you give them a lot of business. Don’t assume that their default terms are the only ones they’ll consider. Ask for a longer payment window, or a discount for faster payment.
If your current vendors aren’t willing to negotiate, consider switching to one of their competitors. The more you can negotiate advantageous payment terms the longer you can push out your DPO, gaining a more favorable DSO to DPO ratio.
Focus on Customer Credit Issues
It’s important to institute customer credit risk policies and apply them consistently, no matter the salesperson making the sale. The goal is to identify risky customers, both current and new, and decide what level of credit risk your organization is willing to face.
You should run thorough credit checks on new customers, and consider rejecting them if their established credit record is worse than your predetermined threshold. You might also consider firing existing customers that consistently allow their invoices to become significantly delinquent. Your organization has a limited number of productive hours. If your services are in demand, it’s worth eliminating bad players so that you can focus on customers that help keep your DSO down.
Have a Rigorous Collections Process in Place
You want all of your AR personnel to be following a consistent collections process. This makes certain that invoices are sent in a timely manner, that payment reminders go out on time and without fail, and that delinquent accounts are handled professionally, and with a level of severity appropriate to the delinquency of the account.
Taken in their entirety, these practices can go a long way to bringing your DSO and DPO into more acceptable ranges, delivering more consistent cash flow and higher working capital levels.