What is DSO?

Cash is king as every business needs cash. This is why it’s crucial to know DSO, which stands for Days Sales Outstanding.

What is DSO?

DSO is a metric that offers businesses a better perspective of their liquidity or cash flow.

It calculates the amount of time a firm has to collect accounts receivables after closing the sale. DSO is a widely used metric as many companies from various industries use it to understand an organization’s financial health better.

How To Calculate DSO?

Different industries may adhere to various approaches in calculating DSO, but there’s a simple formula for calculating DSO.

(Accounts Receivable/Net Credit Sales)x Number of Days= DSO

For example,

Company XYZ has the following:

Total Accounts Receivable of $20,000

Current Accounts Receivable of $5000

Sales made in 30 days on a credit of $15,000

DSO= ($20,000/$5,000)x (30)= 120 days

Using the above example, the DSO is 120 days. This means it will take around 120 days before company XYZ can collect its receivables from clients. Typically, a DSO below 45 days is seen as a low DSO, but this is not set in stone. There is no standardized benchmark as a good DSO varies on the industry, type, and business structure.

It’s worthy to emphasize that only credit sales are in consideration when calculating the DSO. Sales paid for in cash is normally considered to have a zero DSO. This is because cash sales are not factored in when estimating the amount of time it takes for a company to receive the payment after a credit sale.

How does the Traditional Dispute Management Process Work?

The traditional dispute resolution process is time- consuming as it involves redundant and manual paperwork. Plus, it tends to be full of errors. Here’s how it works.

Step 1: Receipt of the Cases under Dispute

The analyst takes the dispute tickets or case provided by either the company’s account department or a client

Step 2: Logging and Tagging

The analyst records the disputes in the company’s tracking system, and tags each case or ticket according to their importance depending on the dispute reason code.

Step 3: Aggregating Data

The analyst gathers all the pertinent information to identify the right persons involved for the invoice under dispute.

The analyst then manually pulls out all relevant information and documents such as order invoice, Proof of Delivery (POD), sales invoice, Bill of Lading (BoL), tax receipt, and other related documents. The analyst then proceeds to study the filed dispute at a superficial level.

Step 4: Requesting Additional Data

When there are missing documents, the analyst gets in touch with the customer to request additional information so the dispute can be resolved quickly.

Step 5: Resolving the Dispute

After obtaining all the related documents, the analyst then proceeds to research for the basis and validity of the filed dispute so he or she can determine the best way of dealing with the disputed item. In particular, the analyst will study whether the dispute should either be refunded, collected, or written-off.

Step 6: Requesting for Further Clarification or Action

The analyst will communicate with the client if he or she finds that the dispute is invalid. The analyst either informs the client of the dispute’s invalidity or seeks additional clarification or a withdrawal of the filed dispute.

Step 7: Seeking Approval

If the analyst deems that the dispute is valid, then he or she will proceed to get the nod of his or her superior. It’s another step that prevents the timely resolution of the dispute and is another task that involves manual paperwork.

Step 8: Issuance of Credit Memo or Debit Memo

The analyst will get in touch with the client to inform that the company will issue either a debit memo or credit memo if the superiors approve the validity of the dispute.

The analyst will also inform the accounts department and request to update the invoice status in the ERP. The account status will be closed once the changes have been reflected in the system.

Step 9: Generating Reports

Manual reports will be generated for the use of executives and managers who will study the deduction functions. Report generation tends to be full of errors and time-consuming when there is no centralized real-time data.

What Makes DSO Important?

DSO can impact a company’s financial function significantly. It is an essential metric showing firms and business owners how well an entity is performing in terms of collecting receivables from their clients. The ratio provides a better appreciation of various business functions, including the following:

  • Speed in which clients payback
  • The firm’s operational liquidity
  • Client relationships
  • Overall sales completed in a specific time frame
  • Accounts Receivable team’s overall performance

Understanding the Difference Between High and Low DSO

Having a good grasp of the differences between low and high DSO will help companies better understand the effectiveness of the Accounts Receivable processes and the firm’s cash conversion cycle.

It is always favorable to have a low DSO as it is indicative of the company’s efficiency and quickness in collecting receivables from its clients. Enterprises with effective collection procedures generally have a lower DSO.

A lower DSO helps avoid writing off payments as bad debts and guarantees quick inflow of operational liquidity.

On the other hand, a high DSO is indicative of the company’s inability to collect accounts receivable within a specific timeframe. Generally, organizations that have ineffective collection processes have a higher DSO.

The high DSO could also be because of clients’ unwillingness or inability to pay back for the service or product. In this case, the firm won’t be able to convert its credit sales into cash or worse, might even end up writing off the payment as a bad debt.

However, a low DSO isn’t precisely always an indication of a company’s efficiency in the collection. Sometimes a low DSO could be because of two reasons:

The net sales are relatively high, which is probably due to the firm’s lenient credit policies. The sales and credit teams might be extending credit terms without conducting a careful risk assessment. In this case, the DSO might be low, but it could result in more payment delinquencies in the future.

The net receivables are relatively low, which means that the collection teams perform well in collecting from clients. This is a good indicator of the company’s financial health.

Strategies to Improve DSO

It’s important to calculate the DSO as it is necessary to determine how the company is performing vis-a-vis industry standards and crafting plans on areas that need improvement. Credit and collections are essential areas affecting the DSO, and up to a certain extent, the company’s cash flow. This is why companies need to optimize credit policies and collection processes to reduce DSO.

Here are some strategies to improve DSO.

Identify High-Risk Clients

Retaining customers is necessary for consistent business growth. However, companies should also pay more attention to clients that are regularly delinquent in payment and re-assess their payment terms and creditworthiness to minimize risks.

Identifying at-risk, critical customers can be done by account segmentation according to associated risks and payment trends. Companies can craft collection strategies according to the client’s risk level. Likewise, the collection team must prioritize clients with at-risk accounts to avoid payment delinquencies and bad debt.

Incentivize Customers

Companies can adopt the carrot-and-stick principle to improve their DSO. Offering incentives to clients who pay early is an effective strategy to lower DSO. Likewise, charging penalties for clients who are consistently late with their payments is also useful.

Provide Various Payment Options to Clients

There’s a downside to offering limited payment options. One of which is that it also restricts clients from paying on time. The current business environment requires the availability of more payment options.

Companies can also offer digital payments to make it easier for customers to pay.

Having a comprehensive order-to-cash automation can help improve the accounts receivable process significantly. Automation is an excellent way for firms to automate payment reminders, standardize collection processes, monitor payment status, and customize customer invoices.

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