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Understanding Accounts Receivable Days and How to Reduce Them in 6 Steps
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What Are Accounts Receivable Days and Why Are They Important?
Accounts receivable days, also known as DSO (Days Sales Outstanding), is a critical indicator of a company's cash flow health. It represents the average number of days it takes for a company to collect payment after a sale has been made. Since cash flow is the lifeblood of any business, the sooner a company receives cash, the better its cash flow and financial position are likely to be. Low interest rates and loose credit conditions often lead companies to neglect managing their DSO. When companies can easily borrow at low rates, they tend to be less concerned about DSO extending by a few days or even longer. However, this can be a risky approach in the long run.
How to Calculate Accounts Receivable Days and Accounts Payable Days
The formula for calculating DSO for a given period is: DSO = (Accounts Receivable / Total Sales) * Number of Days in Period For example, let's say a company sold $50,000 worth of goods last month, and at the end of the month, they had $35,000 in accounts receivable on their balance sheet. The DSO calculation would be: (35,000 / 50,000) * 31 days = 22.3 days This means that, on average, it takes this company 22 days to collect payment after a sale is made. Similarly, the Days Payable Outstanding (DPO) is a mirror indicator that shows how long it takes your company to pay its own invoices: DPO = (Accounts Payable / Cost of Goods Sold) * Number of Days in Period
Benchmarks for Average DSO by Country and Industry
According to a 2019 study
How to Reduce Your Accounts Receivable Days
Reducing DSO requires a collaborative effort not just from your finance and accounting departments, but from various departments across your company. Here are six steps to help lower your DSO:
1. Collect Data on Your Current DSO Status
Start by gathering data on your company's current DSO status and establish a benchmark analysis to show how your DSO compares to your peers and competitors. This provides a starting point and shows what DSO is achievable for your business.
2. Focus on Customer Credit
DSO is often determined by your customers' ability to pay your invoices on time. Establish appropriate criteria for acceptable customer credit risk and apply these standards to both new and existing customers.
3. Determine Customer Payment Terms
Carefully balance your own DSO goals with industry practices and customer expectations when setting payment terms. Clearly communicate these terms on invoices to reduce confusion about when payment is due.
4. Review Your Invoicing Process
Ensure invoices are sent out on time, contain all necessary information, and are free of errors. Regularly review and adjust policies on when to send invoices, considering options like sending them upon contract signing, delivery, or other milestone events.
5. Diligently Manage Accounts Receivable
Have a plan to follow up on unpaid balances and remind customers of outstanding invoices. Focus on identifying any issues preventing customers from paying and consider special arrangements or payment plans for strong customers facing cash flow problems.
6. Maintain Momentum
Commit to reducing DSO as a long-term effort. Regularly review and discuss DSO metrics to reinforce their importance and ensure new habits and procedures stick.
Maximizing Cash Flow by Reducing DSO
Reducing DSO is a relatively straightforward way to strengthen your company's cash flow. It requires focus and sustained effort, but when executives realize the impact of lower DSO, they're likely to provide the necessary support and strategic prioritization. As a digital logistics platform, FreightAmigo understands the importance of efficient cash flow management in the supply chain industry. Our solutions can help streamline your invoicing and payment processes, potentially contributing to reduced DSO.
Conclusion: Accelerate Cash Flow with Smarter Receivables Management
Reducing accounts receivable days is a powerful way to strengthen your cash flow and improve financial health. paced trade environment, optimizing your receivables isn’t just good practice—it’s a strategic advantage.
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