Today we’re going to be talking about the important topic of DSO. DSO stands for Days Sales Outstanding. Most importantly, it means how long it takes for your customers to be paying you. It’s important because it directly relates to how much cash you have, which is the most important factor in the health of your business.
If you sell products or services and no one pays you, you will have no cash. You might have made lots of money on paper, but if you have no cash, you’ll be out of business. It’s very important that we track DSO – days sales outstanding – to understand how long it takes for our customers to pay us.
How to Calculate DSO
The first thing you do is take accounts receivable from the last period. Let’s assume for a second that we’re talking about a month in which we had 30 days. And let’s assume that our accounts receivable is $2 million at the end of a particular month. Then as our denominator, we’re going to use revenue for that particular month. Let’s just assume that our revenue in that month was also $2 million.
That means that we now have a factor of 1. Two million dollars divided by $2 million equals 1. We’re going to multiply this times the number of days in the period. Remember, this is a month that has 30 days in the period. That means that it is taking exactly 30 days for us to get paid. Thirty days from the time that we sell something till we get paid, and this is critical because what you can do with it to increase cash is incredibly important.
How to Improve DSO
Let’s think about all the things you could do. You could go out and invoice your customers faster, or develop better relationships with them. You could change the terms so that you charge interest and penalties, or invoice them more frequently. Instead of once a month, maybe twice a month or once every week. In addition to that, you could go out and do credit checks and background checks on your customers. You could ask for deposits and make sure that you have money ahead of time before you actually send the goods. You could try any number of these things to decrease this number and get paid faster.
But what happens if you do? What if you could get paid just three days faster? If you could get paid three days faster, you could take that 10% of 2 million as an extra $200,000. That’s how much additional cash you’ll have next month if you collect out three days faster and your DSO was 30 days.
Importance of DSO
If you’ve got all this cash, you don’t have to pay interest. You can make payroll, you can buy more inventory, and you can hire more people. You can do all of these things because you just collected your money three days faster. Think about the importance of Days Sales Outstanding, and think about the importance of monitoring how fast you get paid because it has a direct impact on cash, and we all know cash is king.
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