‍

‍

‍

When updating your balance sheet, you may notice trends in your Accounts Receivable (AR) that are disproportionate to your overall sales. This is measured using the metric Days Sales Outstanding (DSO). Changes in your company’s DSO can have greater implications for your business health. Here, we explain the importance of tracking DSO, what it may mean for your financial stability, and how to better manage your DSO when scaling your business.

‍

Understanding DSO and Its Importance

Financial metrics are an indicator of the overall health of your business. Days Sales Outstanding (DSO) is a ratio that measures the average days it takes for a company to collect payment after a sale. The value of measuring DSO is to gauge the efficiency of your company’s credit and collection processes.

A lower DSO indicates faster payment collection, which boosts cash flow and financial stability, while a higher DSO may signal issues in these areas.

We can understand the importance of DSO because of the time value of money concept – a dollar today is worth more than a dollar tomorrow. When you track your company’s DSO over time, you can get clues into your cash flow trends, efficiency metrics, and customer relation management. Together, these insights give a window into your business’s financial operations.

By monitoring DSO, companies can make informed decisions to enhance cash flow and ensure financial stability. In this article, we explain how DSO impacts business health and offer strategies for improving both this ratio and your business performance.

‍

How DSO Impacts Business Health

The DSO reflects how swiftly a business collects cash from its customers. Because most businesses operate on a crediting system, there will always be a delay between providing your service and receiving payment. The DSO simply measures how long this delay is.

In general, a low DSO is a sign of efficient payment collection and robust cash flow. On the other hand, a high DSO can signal the opposite.

‍

Evaluating Your DSO

Interpreting your DSO is relative to your industry. For example, service-based businesses typically have lower DSOs due to shorter payment cycles, while industries with larger, more complex transactions—such as construction or manufacturing—naturally experience longer DSOs. Benchmarking your performance against similar businesses can help you assess if there are any issues with your payment terms.

It’s also helpful to analyze trends in your DSO over time. If the metric is steadily growing year after year, this should be a red flag.

Next, we’ll touch on the insights for your business’s health you can glean by tracking DSO.

‍

Cash Flow Impact

DSO has direct implications for your company’s cash flow (the ratio of money moving in and out of your business). A smaller timeframe between sale and payment translates to more cash on hand. With a positive cash flow, there are more resources to support your day-to-day operations and maintain financial stability.

When your DSO starts to creep up, this constrains your cash flow and makes it more difficult to cover your expenses.

‍

Efficiency Measure

DSO isn't just a number; it's a window into how well a business manages its liquidity. In addition to reflecting how much cash you have on hand, the DSO is an indicator of efficiency in your financial processes. Effectively managing your credit collections supports financial agility. You can measure the efficiency of these processes by tracking your DSO over time. An increasing DSO may flag issues with your approach to credit collections while a decreasing DSO shows that your processes are becoming more efficient.

‍

Financial Health Indicator

All of these data points (DSO, cash flow, and efficiency) can be indicators of your overall financial health. The trends in your DSO impact your ability to both meet your routine financial obligations and work toward your long-term growth goals. For example, a tech firm with a high DSO might struggle to fund its next product launch, impacting its competitive edge. By keeping DSO in check, your finance team can make strategic choices that bolster overall business performance.

‍

Customer Relationship Insight

Tracking DSO helps understand customer payment behaviors. These trends may reveal strengths and weaknesses in your customer relations management and help identify needed adjustments in your credit policies.

‍

Factors Influencing DSO

Because of the impacts that DSO has on your business’s health, you may need to make changes in how you manage payment collection. But before you can take action, you need to understand what factors influence DSO and which ones you have control over.

‍

Credit Policies

You create the credit policies that set the expectations for how and when you are paid. Offering longer payment terms may be appealing to your customers, but it will likely increase your DSO.  At the same time, stricter terms may reduce your DSO, but if not scaffolded properly with your clientele, you may lose customer loyalty. It's important to find a balance that encourages timely payments without straining customer relationships.

‍

Customer Purchasing Behaviors

While you can control what policies you set, you can’t control when your customers make payments. However, looking at trends in your customer’s purchasing behavior can give you clues as to what is impacting your DSO. These patterns can help your team make informed decisions when adjusting credit policies. Holding both your company’s financial health and your customer satisfaction in mind, you can update credit terms to encourage quicker payments.

‍

Economic Conditions

Sometimes economic factors like interest rates and market stability affect your customer’s ability to pay on time. While you can’t proactively address these broader economic trends, you can use financial models to predict possible impacts on your DSO. Staying informed about these trends can help you anticipate changes in payment behavior and position your business to respond gracefully.

‍

Invoice Management Processes

Another factor in your control is your invoice management. Any delays or inaccuracies in your invoicing can extend your DSO. Automating invoicing, as enabled by Fazeshift, ensures timely and accurate billing, helping keep DSO in check.

Addressing these factors involves a mix of internal adjustments and external awareness. Being proactive and adaptable allows you to manage these influences effectively, ensuring healthy cash flow and stable financial operations.

‍

‍

Strategies to Improve DSO

Based on what’s impacting your DSO, you can only control certain aspects of the AR process. While there are only so many times you can follow up with customers about unpaid invoices, there are internal-facing processes that can make your AR more efficient. Here, we highlight actions you can take to shorten your DSO and improve cash flow. These fall into three categories: AR policies, AR tools, and customer relationship strategies.

‍

Improving Your AR Policies

As the payee in the financial transaction, you have the power to set the payment terms. With these policies, the more detail and transparency the better. These terms should specify due dates, acceptable payment methods, and any late fees for overdue payments. Discuss these with each client to make sure every party is on the same page.

Next, it’s your responsibility to send accurate and timely invoices. Avoiding any delays on your end will shorten payment timelines and model the efficiency you hope to receive from your customers.

As part of your payment terms, you can include late fees or early payment discounts to encourage your customers to pay their invoices quickly. As a bonus, clarifying these expectations upfront will help build trust and loyalty with your customer base.

‍

Choosing the Right Automation Tools

Automation tools for AR can help streamline your processes and bring down your DSO. The right tools can save you time and reduce errors while ensuring a smoother collection process. However, choosing automation tools that integrate into your existing workflow can make the difference between a solid or unsound investment.

Some ways that businesses can use automation tools for their finance team include automated invoicing, payment reminders, and AI integrations with AR management.

Automating invoice generation and delivery ensures that invoices are sent immediately after a sale, eliminating delays caused by manual processes. This keeps payment timelines on track from the very beginning.

After the initial invoice is sent, you can use scheduling tools to automate payment reminders of upcoming due dates. This reduces the need for manual follow-ups and encourages timely payment, which in turn lowers DSO.

Along with scheduling automation, AI can support your end-to-end AR processes. AI tools can predict potential payment delays and help reduce unpaid invoices. Additionally, AI-powered automation can handle repetitive tasks like data entry and reconciliation, freeing up your team to focus on more strategic priorities.

Fazeshift's AI-powered platform can transform sales contracts into invoices instantly, handle complex billing terms, and automate payment matching. To explore how our solution can be tailored to your needs, consider scheduling a demo with our sales team.

‍

Strengthening Customer Relationships

Improving your DSO isn’t just the responsibility of your finance team. Building good relationships with customers can improve payment timeliness. Collaborate with your customer management team to improve regular communication and understand customer needs. A team that is aligned on similar goals facilitates a smoother payment process.

‍

Software Solutions for DSO Management

While financial tracking and reporting software aren’t new, tools designed specifically for your Accounts Receivable are. Recent innovations in AR tech have revolutionized how businesses manage DSO.

Consider the impact of automation. Fazeshift's AI-powered platform automates billing, payment collections, and cash applications. As soon as you make a sale, Fazeshift uses the contract to instantly generate an accurate invoice for your customer, effectively removing any lag time from your end of the payment process. Then, when you receive the payment, Fazeshift applies it to the correct customer’s account and reflects the completed sale on your balance sheet. The result? A significant reduction in DSO, improving the company's financial health.

Businesses that embrace tools like Fazeshift see a tangible impact. A report from PYMNTS found that 91% of mid-sized firms that have fully automated AR processes saw increased savings, cash flow, and growth.

‍

Challenges and Limitations of DSO

While DSO can be an informative financial metric, it’s not perfect.

One major hurdle lies in the variations of credit terms across businesses. Different industries or companies might have diverse credit agreements, making DSO comparisons tricky. For instance, a company offering 60-day credit terms might inherently show a higher DSO than one with 30-day terms, even if both are equally efficient in collections.

DSO can also be skewed by seasonal sales fluctuations. Businesses that experience peaks during certain times of the year may see temporary changes in DSO, which might not accurately reflect their typical cash flow efficiency. In these cases, annual DSO may be a more helpful metric rather than comparing quarterly reports to one another.

Industry-specific trends further complicate things. Some industries naturally have longer payment cycles due to the nature of their transactions. This can lead to misleading comparisons if not accounted for.

• Credit Term Variations: Different credit agreements affect DSO comparisons.
• Seasonal Fluctuations: Peaks in sales can distort DSO temporarily.
• Industry Trends: Certain sectors have inherently longer payment cycles.

To effectively use DSO, it should be part of a broader financial strategy. Businesses can overcome these challenges by contextualizing their DSO analysis, considering industry norms, and using it alongside other metrics. This balanced approach ensures a more accurate performance assessment, aiding in strategic decision-making.

‍

‍

Key Takeaways on DSO and Business Health

Days Sales Outstanding (DSO) is an indicator of your business's financial health. It shows how quickly you collect payments, affecting cash flow and stability. Understanding how to manage DSO can help you improve your financial processes.

One strategy to improve your DSO is to automate your AR process. Automation tools can streamline the workflow for your finance team and reduce errors in your invoicing and accounting processes. That’s what we offer with Fazeshift: AI-powered software to simplify billing and smooth collections.

By leveraging tools like Fazeshift, finance teams can refocus their attention on growth initiatives rather than chasing down payments. For those interested in exploring how Fazeshift can enhance your AR efficiency, schedule a demo with our sales team.

‍