DSO is the number of days it takes a company to collect payment on a completed sale. Which means the length of DSO directly impacts a company’s cash flow: the greater the DSO figure, the lower the company’s liquidity.
A low DSO number reflects shorter, or immediate, payment collection, while a high DSO number shows a company is selling products on credit and taking longer to receive payment. The higher the DSO, the lower the cash flow.
In general, SMEs are more impacted by delays in payment and cash flow than larger businesses. Yet, typically, their dependence on a smaller pool of clients means they are often reticent to chase payment too aggressively. But the longer it takes to receive payment, the greater delay in reinvesting that money into the business, affecting revenue stream and growth opportunities.
DSO can also be used by others to evaluate a company’s efficiency. So your DSO numbers could create, or deter, further business. This is because, over time, companies with a high DSO figure are more susceptible to inefficiency.
The first way to do this is through fast and accurate billing. The sooner an invoice is issued and received by the customer, the sooner the agreed payment period begins. And when customers fail to pay within the specified time period (often 30 days), they may start to incur late payment charges to offset your financial disadvantage. So invoicing swiftly can offer you some financial protection for your business.
Additionally, fast payment incentives – where a customer receives a favourable reduction for swifter payment – may incentivise customers and improve your cash flow. Another way to reduce your DSO is to enable online payment; a reliable way to accelerate payment, maximise efficiency for both parties and improve your cash flow.
Managing accounts efficiently is crucial to reducing your DSO. Staying on top of outstanding payments means you can address them more swiftly with the client, instead of losing valuable time spent identifying which payments are outstanding.
Proactive account management also extends to managing payments. Delays in processing payments may impact the customer’s own finance sheet. If this happens regularly, it may deter customers from doing business with you in future – not least because it raises questions around your company’s efficiency. Due diligence As important as optimising your processes, is finding out the financial health of your customer. You could have excellent processes in place, but if a client is not in a position to repay credit then your options are dramatically reduced. This is where due diligence comes in: make sure you know who you’re extending credit to.
If your client is a publicly-listed company, insight into their accounts should be available on Company House. Compare their annual turnover to the value of the credit you extend – this will give some indication of their likely cash flow.
You can also check their credit rating to give you an idea of their financial strength; almost all businesses in the UK have a credit rating.
Taking this due diligence further, you can research a company’s payment culture through the government-supported Prompt Payment Code. Companies that sign up undertake to pay their suppliers on time. Those that fail are named and shamed. So you can find out how likely a company is to pay you on time before you opt to do business with them; protecting your business, cash flow and DSO ratio.