What is DSO?
Days Sales Outstanding(DSO) calculates the average number of days to collect a company’s receivables after a sale has been made. DSO is a popular metric across different industries. It reflects the health of an organisation’s accounts receivables indirectly pointing out how the Credit and Collections teams are performing.
Methods to Calculate DSO:
Various industries follow different approaches to calculate their DSO. Primarily, it is calculated using the following two methods:
Rolling Average Method:
- In this method, DSO is calculated in every three/six/twelve months interval.
- This type of calculation is prevalent in industries which experience a lot of seasonal sales spikes or fluctuations such as media & publishing industry. For instance, the greeting card industry faces a huge sales spike during Christmas or other festive seasons.
- In this method, DSO is calculated at the end of each month or quarter.
- This type of calculation is more effective for the performance evaluation of A/R teams.
- Through this evaluation, the managers & directors could modify their long term strategies as well as short term goals for better results.
Moreover, an organisation could streamline its performance by tracking and calculating DSO at an account level or a regional level. For instance, credit professionals could track DSO separately for customers based out of US and UK and tweak credit policies based on geographical trends.
Common Instances Where Organisations Misinterpret DSO:
DSO is just a number. It is critical for credit and collections managers to understand and plan for the next action items based on it. The following use-cases would explain how senior management often fails to leverage DSO to improve their business processes.
Judging DSO Without Knowing the Payment Terms:
From the graph, it is evident that the DSO of Colgate is 34.09 and the DSO of P&G is 25.15. Does this mean that Colgate has a scope of improvement in collecting its receivables? This might not be true because we are not aware of Colgate’s payment terms. If the payment term of Colgate is 30 days, then there is definitely scope for improvement, while if the payment term is 60 days, then we could say that their Collections efforts are in right place.
Judging DSO Without Gathering Information from Sales
As we know,
DSO is highly influenced by Sales teams. The following two examples support this statement:
- Customers tend to delay their payments during a fiscal year-end. If the Sales teams close a deal towards the end of a month and expect the customers to pay on time during a financial close, it would rather lead to an increased DSO count.
- Influenced by the competitor’s activities, if the Sales teams offer an extended payment term to their customers, this is often viewed as an opportunity to secure more revenue. However, this leads to increased DSO.
This is why before jumping to a conclusion, the Credit and Collections teams should have a knowledge transfer with Sales teams.
Judging DSO Without Monitoring Your Invoicing Process
Imagine you are sending multiple payment reminders to your customers but they have not received the invoice at all. Also, they would not pay for an incorrect invoice. One fault of your Billing & Invoicing team could undermine the customer experience, along with an increase in DSO.
Companies need to do a customer-wise analysis of invoice acknowledgement. This would help them understand whether the customers have received their invoices on time or not. DSO evaluation should be dissected on the basis of faulty invoices, late invoices to have more insights. To have better tracking of billing & invoicing, organisations should resort to EIPP.
A wrong approach to judge DSO could lead to the setting of unrealistic targets by senior management. For example, while undertaking digital automation projects, you might end up setting wrong DSO targets in the ROI calculation. This would result in an improper action plan which might be counter-productive for the organisation’s A/R operations.
Things to Keep in Mind While Analysing DSO:
Often DSO analysis and interpretation need a lot of research around the circumstances which led to the DSO. The following parameters should be kept in mind while evaluating DSO reports:
- Collaboration with Credit & Sales teams about the payment terms
- Proofreading the invoicing process before sending payment reminders to customers
- Communication with Credit & Collections team about customer payment terms & delinquent accounts
To gain more insights on this, read this ebook on how to reduce DSO by 15%.
Tips to Improve DSO: How to Scale Your Business Processes
A win-win strategy is necessary to scale up DSO which would in-turn impact the bottom-line of your organisation. Some best practices to improve DSO are:
Improved payment terms
Payment terms should be customer-specific and should be tracked properly.
Error-proof invoicing processes
Billing & invoicing should be regularly tracked to ensure minimal errors and faster invoice delivery.
Critical evaluation of customer credit
Customer credit risk evaluation is important to make sure that the Credit & Collections teams are not onboarding high-risk customers with lenient credit policy.
Credit and Collections teams should properly prioritise, prepare call scripts, perform ageing analysis before calling up a customer.
What Metrics Should Be Analysed Along With DSO: Way to a Holistic Approach
DSO as a metric leaves room for assumptions. So, it is better to analyze DSO collectively with a few other metrics. This would help the senior management to get a clearer picture of what the bottlenecks are, and what the next action item should be.
Collections Effectiveness Index(CEI)
To analyse the performance of the Order-to-Cash teams, CEI is perhaps the best metric to consider along with DSO. CEI helps the senior management to understand how effectively their Collections team is performing. To know more about CEI, read our next blog.
Bad Debt to Sales:
Bad debt to Sales directly shows how much amount had to be written off as the customers were unable to pay their dues. This KPI is calculated as a ratio, and if the ratio tends to increase with time, then it reflects ineffective credit policies and management.
Days Deduction Outstanding:
DDO is calculated and considered to get an idea of how the organisation is dealing with its Deductions. It is calculated by dividing the outstanding deductions to the average deductions which were faced during last three/six/twelve months.
Accounts Receivable Turnover Ratio
A/R turnover ratio is a metric which specifies how efficiently an organisation is collecting its assets. A higher A/R turnover ratio is recommended as it reflects a strict credit policy and effective collections of receivables.
Best Possible Days Sales Outstanding
BPDSO is a theoretically-calculated metric which specifies the best possible number of days in which an organisation could collect its receivables. The motive behind calculating BPDSO is to initiate an internal comparison between the DSO and BPDSO so that the senior management can set a right approach to benchmarking.