Having a proper understanding of the current financial condition is vital to the management of any organization. It falls to the accounting department to provide the management with the necessary data they need to ensure the continued financial health of the organization. Several metrics and concepts are monitored and used in this regard such as DSO, short for Days Sales Outstanding. In fact, DSO is easily one of the most important metrics that the accountants deal with.
What is DSO?
DSO can be defined as the average number of days taken by an organization to collect the revenue after the conclusion of a sale. In other words, it refers to the average time required for collection. This financial metric can be used for determining how effective the organization is at managing the accounts receivables of the organization.
Generally, the DSO is calculated on a monthly basis but quarterly or annual calculations are not uncommon. A lower DSO value shows that fewer days are taken by the organization to collect the money due from accounts receivable. A higher DSO value can indicate that the organization sells on credits, taking a longer period of time with its collections.
The DSO will be typically calculated every month or every period. This way, the accountants and the management will gain a better understanding of their DSO trends and see if any improvements have been made.
How to Calculate Days Sales Outstanding?
The days sales outstanding calculation is rather simple. The formula used is given below.
There are other variations of the formula that can be used by organizations depending on how it conducts its business. However, irrespective of the formula used, the day sales outstanding value will be the same.
How to Improve Your DSO?
There are quite a few things which can be done to reduce DSO. Reduction of DSO is essential for the organization to remain liquid. Here are few tips that can be implemented.
Reduce Billing Time: Implementation of fast invoicing can easily reduce the DSO. Delaying the sending of the invoice will cause the customer to take more time to make the payments. For speeding up the billing process, use of automation tools can be immensely beneficial. Use of tools can automate the process and reduce the billing period to a few days instead of a week or two. Faster billing ensures that the payment process is consistent and can encourage clients and customers to pay up.
Incentivize Faster Payments: Clients may often make excuses for delaying their payments. They might have genuine reasons for the delay or they are simply stalling. Irrespective of the reasons, the fact remains that the organization is not getting the cash. Providing incentives can help in speeding up the payment process.
A good method would be to maintain credit cards on file. This enables the payment to be charged as required. However, it is essential that the customer be notified before the payment is charged. Ensure that this is mentioned in the payment contracts finalized with the clients.
Get Rid Of Bad Clients: For certain clients with high days of sales outstanding, the only option is to get rid of them. This might go against norms but it might be necessary to balance costs. The accounting department can help in determining the costs involved in retaining these clients. Typically, the costs arise out of extra activities related to collections, sending multiple invoices as well as the lost use of necessary cash. In some cases, the costs can be rather high. Retaining such clients may not seem like a viable option.
Benefits of DSO Reduction
If the DSO is not reduced, the organization’s finances will be negatively affected. The most discernable of these effects is the loss of revenue. The absence of cash may make it harder to pay the monthly accounts payable such as operational costs. It becomes more difficult to bring about a growth in the operations. This may create the need for outside financing, resulting in an increased financial burden. Opportunities to expand might be lost while administrative costs arising out of the collections may increase. As such, reducing the DSO has several benefits.
DSO improvement is vital for any organization. The longer the delay in closing accounts receivable, the harder it can be to ensure the financial health of the organization.
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