Why improve your DSO?
Working capital requirement (WCR ) is a company’s capital requirement corresponding to the time lag between cash outflows (payment of purchases) and inflows (payment of sales). This is the capital required to finance a company’s operating cycle. WCR can be expressed as an amount or as a number of days.
If calculated in days (DWC: Days Working Capital), WCR is the result of three indicators:
– DSO (Days Sales Outstanding): number of days to receive payment from the customer
– DIO (Days Inventories Outstanding): number of days an item remains in stock.
– DPO (Days Payable Outstanding): number of days to pay suppliers
In this article we will look specifically at DSO
Role and calculation of DSO
DSO definition
DSO is a measure of customer risk, providing an indication of the efficiency of a company’s collection process and its ability to analyze and anticipate customer risk.
The difference between the theoretical DSO or BPDSO (Best Possible DSO) – which measures the DSO assuming that all customers pay their invoices on time – is used to measure the potential for improvement.
DSO calul
How do you calculate DSO? There are 2 main ways of calculating DSO: the accounting method and the “count back” (or “roll back”) method.
Improving DSO is essential, as trade receivables have a direct impact on working capital. Over 25% of SMEs go bankrupt due to a lack of cash, while many others survive but are hampered in their ability to innovate and grow due to a lack of cash. This lack of innovation has a direct impact on their ability to differentiate themselves from the competition, and therefore to grow.
Improving DSO – the Credit Manager’s preventive role
To improve DSO, the Credit Manager has 2 critical preventive missions: analyzing performance and anticipating customer risk. All in collaboration with the company’s various departments, including sales.
Performance analysis:
The Credit Manager must be able to analyze the company’s performance finely and, above all, quickly. It must have the resources to monitor outstanding receivables, sales, DSO trends, the aged trial balance and the impact of disputes on cash flow in real time.
The objective for the credit manager is to be able to use his dashboards to identify areas of performance, but also and above all areas of under-performance. The credit manager will only be able to define the right action plan for improvement if he can identify the reasons for the deviation from the BPDSO (Best Possible DSO or theoretical DSO). Is the improvement zone a specific customer segment? a subsidiary? a geographical area? an agency? Is it related to late payments or unpaid bills?
This analysis and these pragmatic dashboards will then enable him to better spread the cash culture within the company and to better collaborate with sales management, for example in defining commercial policy on payment terms or credit limits.
This analysis will also enable the company to better anticipate its customer risk and better define its risk hedging strategy.
Customer risk analysis:
To improve their DSO, credit managers need the tools they need to understand their customer risk. To achieve this, they need to be able to easily find all their customer information in a single place, in a single credit management software package that’s both simple and ergonomic.
It must also be able to accurately analyze the evolution of each customer’s payment behavior through a scoring system.
Today, many companies offer scorings linked mainly to the financial health of the company. These scorings are essential, but companies increasingly share the view that a healthy company can be a bad payer, and an unhealthy company a very good payer. Moreover, a company can be a very good payer for one supplier and a very bad one for another. It is also important to note the impact of confidential balance sheets on the ability of these companies to assess a company’s financial health.
Hence the need to know in real time how your customer’s payment behavior is evolving in relation to their history with your company. Depending on the payment behavior of a given customer, you can automatically define the best dunning and debt collection scenario.
Improving DSO – Credit managers’ risk hedging choices
The credit manager can choose between 2 main risk hedging methods:
Credit insurance
With credit insurance, the credit manager can transfer the risk of non-payment to a third party such as Atradius, Euler Hermes, Coface or others. This solution is extremely effective, provided that it is managed precisely and efficiently, and that it monitors changes in warranty limits, contractual notice periods, etc. Tools exist to simplify this management process. These tools act as digital personal assistants to simplify credit insurance management and notify the credit manager of essential tasks (e.g. whether one of my customers’ actual outstandings exceeds the guarantee limit).
Factoring
With factoring, a company can be paid immediately for an invoice, instead of having to wait for the due date. There are many different types of factoring, including traditional full factoring, delegated factoring, full factoring, partial factoring and invoice factoring, with different assignment methods, such as line-by-line factoring. It’s essential to take the time to analyze the type of factoring contract best suited to your business. From a technical point of view, factoring will require regular, recurring transfers of financing, which may or may not be automated, just like the technical link to the factor.
Improving your DSO – The Credit Manager and optimizing debt collection
After analyzing DSO performance and customer risk, and whether or not to cover this risk with credit insurance or factoring, the credit manager can concentrate on a major source of cash: invoices awaiting payment.
The customer workstation
In most companies, trade receivables represent close to 40% of company assets. Unfortunately, in many companies, the debt collection process is still largely manual, especially in SMEs. The tasks are repetitive and time- and resource-intensive. These tasks are perfectly eligible for automation by means of processing algorithms.
Task automation
Automatic dunning software then automates around 80% of actions, focusing employees on higher value-added tasks such as analyzing performance and customer risk, and on the really essential, high-priority collection tasks. A debt collector will always have much more impact on improving DSO by calling the 5 critical files to bring in cash than by sending 150 more or less standard emails.
These tasks must be automated in an intelligent and personalized way to protect customer relationships. The reminder for a major account must be different from the reminder for a small customer, a very large invoice from a small one, a good payer from a bad payer, etc…. This differentiation is a key factor for success, as is the ability to easily and autonomously adapt letters, emails or reminder scenarios.
This automation must also enable simple, effective collaboration between company departments (sales, advising, credit management, litigation, etc.), to ensure more efficient processing of overdue items. This is known as collaborative workflow.
On average, companies that have implemented this type of approach see their cash collection increase by more than 25% and their administrative tasks fall by more than 50%. Late payments are very often divided by 2. This allows us to generate better cash flow, faster and with constant resources.
Improve your DSO – The Credit Manager and litigation management
Around 35% of invoices over 30 days overdue are linked to a dispute. Yet many companies are still penalized by the lack of traceability of disputes, or by the lack of tools enabling them to collaborate effectively on a dispute. Here again, solutions exist, and it’s essential for a company to be able to ensure the proper traceability and collaboration around these disputes.
3 major benefits: faster processing of claims and therefore faster cash flow, improved customer satisfaction and better internal collaboration.