Why DSO Should Be a Focus KPI For Your Company (And Other Ways to Measure Your Accounts Receivable Performance)
Companies have quite a few ways to measure their accounts receivable performance. One KPI that provides particularly valuable insight: your DSO, or days sales outstanding.
A DSO analysis can show you how effectively you’re collecting payment for your products or services, and how that relates to your company’s cash flow. By knowing how many days your sales are held up in receivables, you can evaluate your invoicing practices, credit terms, and financial projections on a more strategic basis.
How Do You Calculate DSO?
To calculate your DSO KPI, you’ll first need to pick a reporting period: most companies run reports monthly, quarterly, or yearly. (Any shorter of a period, and you’re not getting a large enough sample to accurately reflect your performance.)
The typical formula:
- Divide your accounts receivable balance for your specific reporting period by its total credit sales
- Multiply that by the number of days in the period (e.g., 365 for a yearly metric, or 92 days for a Q3 KPI)
The final figure is your days sales outstanding.
What’s the Average DSO?
Per an APQC survey published in CFO magazine, the most efficient companies report a DSO of 30 days or less. The longest DSOs were in the 48 day range, while 36 days was the median.
When comparing your DSOs to the average, note that many different things can influence your accounts receivable performance. For certain companies, 48 days – the “poorest performance” metric from the APQC study – is actually an excellent DSO for their particular industry.
Average DSO by Industry
According to SageWorks, there are a handful of industries for which a DSO of 60+ days is considered average. These include:
- Management consulting (125.07 days)
- Oil and gas extraction (110.86 days)
- Technical and trade schools (109.32 days)
- Automotive equipment rental and leasing (104.35 days)
- Outpatient care centers (98.99 days)
- Mining support (90.76 days)
- Architectural and engineering services (74.36 days)
- Scientific research and development (70.75 days)
- Foundation, structure, and building exterior contracting (67.46 days)
- Heavy and civil engineering construction (66.51 days)
To put your DSO into perspective, be sure to consider the average expectations in your industry. If competitors typically have longer payment cycles, yours may very well be on the longer side as well; it could simply be a side effect of your industry’s business model.
DSO and Sales Fluctuations
On a similar note – the same way that it’s normal for certain industries to have “slow seasons”, it’s also normal for certain companies to have periods when their DSOs are higher than normal. If your current accounts receivable balance includes one or two large orders that are several months old, that can cause your numbers to be skewed.
DSO calculation methods that focus on a 12-month average don’t let you account for periods where your monthly sales are higher (or lower) than the norm. This is why most companies use a monthly (or quarterly) KPI, then compare their current number to the benchmark from the same period in the previous year.
DSO by Customer Base
Another thing to keep in mind: some companies choose to offer more lenient terms to larger customers. For example, a major account that provides a larger share of a company’s revenue may be asked to pay within 60 or 90 days, while smaller accounts may be asked to pay more quickly. One or two such accounts can increase the average number of days that your sales go uncollected.
Depending on your invoicing terms, you’ll likely want your DSO to fall within 20 percent of your standard policy. For instance, 36 days should be your maximum target if you request payment from a typical customer within 30 days.
The Problem with a High DSO
If your DSO KPI is too high, your cash flow will likely suffer. Because you won’t have access to your profits right away, you’ll need to come up with a strategy for covering the costs of overhead while you wait for payment. Plus, the more sales you have to send to a collections agency, the more time (and money!) your company ends up wasting.
Improving Your DSO
There are several ways you can improve your days sales outstanding. For instance, you can:
- Re-evaluate your credit practices
- Invoice your customers more quickly
- Offer incentives for faster payment
(This article is part one in a two-part series. For more in-depth strategies, check out part two: our in-depth guide to reducing your DSO).
Of course, DSOs are just one financial KPI for you to monitor. You can also take into account the number of days that pass from an invoice’s due date to the date it’s actually paid (your average days delinquent), the number of invoices you collected compared to the number of invoices you sent out (your collection effectiveness index), and the net value of your credit sales as they compare to your average accounts receivable balance (your accounts receivable turnover ratio).
Workflow Automation for Faster, More Efficient Accounts Receivable
If your cash flow is typically strong, there’s no need to worry – even if your DSO is on the high side for your industry or company history. But, if you’re consistently running into issues, it may be time to consider some changes.
At IntelliChief, we can help. Our accounts receivable solutions make it possible to invoice customers more quickly, reduce lead times, and gain more visibility into your entire order to cash cycle.
Ready to improve your accounts receivable metrics? Contact us today to learn more about reducing your DSOs (and meeting other crucial KPIs) with strategic AR automation.