Cash Flow Strategy: Reduce Days Sales Outstanding
Cash flow is the lifeblood of any business. Consequently, running into cash flow problems can quickly drain the life out of a business. Steady cash flow strengthens an organization’s financial position. When no money is coming in, people tend to stop working or providing services. It is important for small businesses to monitor their financial statements and manage cash flow in order to have cash on hand to run day-to-day business operations.
Monitor Days Sales Outstanding (DSO)
Businesses want their customers to pay them sooner rather than later because on-time payments are essential to business operations. Companies may notice that their day's sales outstanding (DSO) are higher than they’d like, creating a cash flow problem. Days Sales Outstanding is a key benchmark that businesses use to track cash flow. Basically, DSO is the number of days it takes for a business to convert accounts receivables into cash. To calculate DSO, use the DSO formula for a given period:
DSO = (accounts receivables / total sales) * number of days
Cash Flow Strategy: Reduce Days Sales Outstanding
For example, let’s say that XYZ Company sold $10,000 worth of goods and services, with $7,500 in accounts receivable on its balance sheet at the end of the month. Prosperity Bookkeeping’s DSO would be (7,500 / 10,000) * 31 = 23.25. This means that it took about 23 days to collect payment for products and services. That’s pretty good, especially compared with the national average. A 2019 study of Days Sales Outstanding conducted by Euler Hermes found the average DSO was 51 days.
Make Reasonable Credit Decisions
Reducing DSO requires a focused effort from a company’s finance, accounting, and sales departments. The first factor to consider is the customers’ ability to pay their invoices. Companies should develop appropriate guidelines for customer credit to lower the risk of slow payment or nonpayment. To encourage faster payments, small businesses can offer customer incentives. Likewise, companies can ask for money down before a job starts and partial payments until the job is completed.
Improve Invoicing Methods
Invoicing is one of the most important phases in the cash cycle. Small businesses have many opportunities to reduce DSO simply by being smart with their invoicing.
Invoicing Guide to Reduce DSO
- Automate invoicing – Automation saves time otherwise spent manually processing invoices and speeds up the overall process
- Send invoices on time – Invoices should be sent based on a milestone, such as when a contract is signed, the 1st of the month, at job completion, etc.
- Send invoices to the person or department responsible for payment – Accounts Receivable can check QuickBooks to see if and when someone viewed an electronic invoice
- Include all necessary information on invoices – Use a template that clearly defines payment terms, due dates, and remittance instructions including address
- Proofread invoices carefully – Correcting and resubmitting invoices delays payment
- Manage accounts receivable – Late payments happen. When payment is overdue, be polite but persistent. Send reminders and over time, figure out a way to light a fire under them
Cash Flow Strategy: Reduce Days Sales Outstanding
- Arrange a payment plan – Make special arrangements to accommodate slow-to-pay customers
Strengthen Cash Flow by Reducing DSO
Reducing DSO is a sure-fire way to maintain a steady cash flow, but this strategy involves some effort. The process starts with updating administrative policies and practices for bookkeeping and sales departments. The results are worth it. By lowering DSO, organizations increase profitability and improve cash flow.
Contact Prosperity Bookkeeping
Track your business’ cash flow with resources from Prosperity Bookkeeping. We have proven systems that help small businesses put their money to work for them. Contact us for fully integrated accounting processes, bookkeeping, and consultation services.