What is DSO and what does it mean for me?
DSO, or days sales outstanding, is the length of time it takes a business to receive payment after invoicing. An elevated DSO may indicate that a customer is struggling to pay bills on time. However, in some cases, a higher DSO can actually represent a successful business. Businesses that operate with a high level of trust and strong credit management practices tend to offer longer-term payment opportunities for their customers, therefore increasing their DSO. Moreover, some businesses with a higher DSO often have strong relationships and a solid foundation of open communication with their customers.
Before we discuss how to maximize your DSO to benefit you and your customers, you will need to first determine your current DSO. To calculate the DSO ratio, divide your accounts receivable by annual sales per day. You can also use our DSO Calculator based on industry data driven by the Credit Research Foundation.
DSO = (total receivables at year-end / total annual credit sales) x 365 days
An alternative DSO formula focuses on your current account receivables and gives a more accurate picture of your DSO at any given moment:
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DSO = (current accounts receivable / total credit sales) x number of days
After determining your DSO ratio, you will need to consider whether you need to adjust your reduction strategy. For example, if you have a customer that is repeatedly delinquent on their payments, this can negatively affect the cashflow of your business.
Several strategies can help you maximize DSO to benefit you and your customers. An effective DSO ratio will ensure a healthy cash flow for your business while making sure you are attracting new customers and staying competitive within your market.
Maximizing DSO for Business Growth
- Focus on communication. Poor communication between you and your customer could put a strain on the business relationship. Communicating thoroughly during the entire payments process will help minimize errors. Be transparent about any changes in credit policies and communicate with each other often.
- Avoid the horizon of risk. Any business that has a delay in payment is at an increased risk of payment default, also known as having an increased “horizon of risk.” The wider the “horizon,” the more likely it is that something can go wrong. You can decrease the horizon of risk if a customer demands payment upfront by ensuring you have a low DSO rate.
- Consider a flexible approach. Measure the terms of your credit payments according to you and your customers’ needs. For example, payment expectations for businesses could differ from country to country due to cultural differences. Flexibility will also strengthen the relationship between you and your customers in the long run.
- Understand the business sector. Not all credit terms are created equal. It is important to weigh your geographic location and even the market sector in which your business operates. For example, the agri-food and fuel sectors usually require the shortest payment terms, typically less than 30 days, whereas the finance sector can be quite long, often more than 90 days.
To find out the average payment terms for your market, see the Atradius Payment Practices Barometer, which publishes payment trends in regions, countries, and sectors. And for more on achieving your credit management goals visit atradius.us or contact us at firstname.lastname@example.org.