How to reduce the number of unpaid sales days and enrich cash flow

As businesses strive for financial success, an often-overlooked statistic is Days-Of-Sales (DSO).

But what exactly is DSO, and why should CFOs pay attention to it?

This article discusses how CFOs can improve their company's financial health and manage its cash conversion cycle.

You'll dive into DSO, including how it's calculated and what it means for working capital management. You'll also explore the impact of high and low DSO and examples of how optimizing DSO can positively impact a company's operating cash flow and overall financial performance. p> What is Days Outstanding Sales (DSO)?

Days Outstanding Sales (DSO) is a financial metric used to measure the average number of days a business takes to collect payment from customers after a sale. It is also called the average collection period.

To calculate DSO, divide accounts receivable by total credit sales and multiply the result by the number of days.

Source: Bilendo

Accounts Receivable is the amount of money customers owe a business. Total credit sales is the total amount of sales made on credit during a given period (usually a month or a quarter). The number of days is the number of days in the same period.

Example: If a company had $100,000 in accounts receivable, $400,000 in credit sales for the month, and the month had 30 days, the DSO value would be: ($100,000/$400,000) x 30 = 7.5

Derived: On average, it takes a business 7.5 days to collect payment from customers after a sale is made.

With the help of the determined value, conclusions can be drawn about various factors and initiate measures against the associated cash flow problems. Additionally, DSO is one of the three primary metrics measuring a company's cash conversion cycle.

Why is the DSO so important?

The DSO measures the financial health of a company. When companies continuously monitor their DSO, they get valuable insights into their cash flow and working capital management.

Good management of cash flow and working capital is essential to the performance and growth of a business. When a company's collection process is inefficient and payments are not received on time, the likelihood of a cash shortage increases.

Tracking DSO over time allows you to identify trends and adjust your sales and collection processes to improve cash flow. For example, adjusting your credit policy reduces the risk of customer default.

Additionally, you can use DSO as a benchmarking tool to compare your performance with your peers in the same industry. Comparing your DSO with your competitors indicates how well you manage your accounts receivable.

If your DSO exceeds your peers, your business takes longer to collect payments. This could signal financial difficulties or inefficiencies in your accounts receivable management process. A high DSO can lead to cash flow problems and negatively affect the profitability of your business, because you have to wait longer to obtain the income already generated.

On the other hand, if your DSO is lower, your business collects payments faster, indicating an efficient and effective accounts receivable management process. This improves cash flow, increases profitability and better manages financial risk.

In general, you should keep the DSO as low as possible, because a low DSO allows you to use your full financial potential. You also prevent financial losses and avoid insolvency. A low DSO is especially important for companies with little available capital to maintain low capital commitments and high capital efficiency.

Why should companies monitor DSO?

DSO reports effective credit and collection policies.

High DSO values ​​indicate higher credit risk. Due to longer collection periods, you may have higher accounts receivable. This can lead to cash flow problems if customers do not pay on time or if bad debts are written off.

However, DSO is not the only valid indicator of credit risk. External factors (beyond a company's control) also contribute to the level of credit risk, such as customer payment behavior, economic conditions and industry trends.