10 Essential Steps to Effectively Reduce Your Company's DSO

The management of a company's accounts receivable is a vital issue. DSO is a key financial indicator for assessing whether a company is collecting its customers’ payments efficiently, or whether there are shortcomings that are weighing on working capital. This article is aimed at CFOs, credit managers and the finance function. We will detail the 10-step method for reducing DSO and implementing an effective receivables management method. We'll then take a look at the experience of a company that has implemented some of these best practices.

A quick review of the basics before getting started:

What is DSO in finance? Definition

The acronym DSO stands for Days Sales Outstanding, in other words, the average time between when a customer is invoiced and when the bill is paid. DSO is a key financial indicator, reflecting a company's financial health.

How is DSO calculated?

DSO is calculated as follows: Receivables incl. VAT X Number of days / Sales.

Bear in mind, however, that this indicator is highly volatile, and we recommend that you interpret it over a sliding 6-month period.

How can you reduce trade receivables?

Reducing trade receivables will help you secure your cash flow, reduce the risk of non-payment and improve your relationship with your customers. To control and reduce trade receivables, it is advisable to monitor your company's DSO. This article explains how.

The importance of reducing DSO (Days Sales Outstanding)

DSO is an indicator of a company's financial health, reflecting the time that elapses between the moment a customer is invoiced and the moment the bill is paid. It has a direct impact on a company's WCR, as it represents the time it takes to collect receivables. The faster a company collects trade receivables, the faster it has available cash. This reduces its WCR (assuming inventories and supplier payments remain the same), and increases its financial security and investment capacity.

Steps to reduce DSO

1/ Appoint a manager

By appointing someone to be responsible for improving the order-to-cash cycle, you ensure that DSO reduction is kept under control. This is all the more important if you don't have a credit manager. This person will guarantee the success of your DSO reduction strategy, and will be responsible for implementing the points we'll detail next.

2/ Define the indicators to be measured

Stopping at DSO alone could lead to erroneous analyses, depending on your market, its seasonality and the way your business operates. Several secondary indicators exist to measure collection performance: they will help you to enhance your analysis and set more precise objectives.

Firstly, BP DSO, which stands for Best Possible DSO. This indicator focuses on current invoices, rather than measuring the time taken to pay current and overdue invoices, as the classic DSO does. It therefore assumes that all invoices are paid on time. Analysing the delta between DSO and BP DSO will enable you to set slightly more ambitious targets, based on the assumption that your upstream cash collection strategy is effective (we'll go into more detail in points 5 and 6).

You can also calculate the DSO due (or "count back"). The principle is to deduct sales (including VAT) from the balance of accounts receivable on a monthly basis, and add up the corresponding days until the balance is exhausted. This approach takes into account seasonality and sales variations.

3/ Set clear objectives

Now that you know which indicators you want to measure, you can set a quantified objective with a clear timeframe. Don't hesitate to adjust this objective according to the gaps between what you had planned and the reality. Example: reduce the company's DSO by 10% within 6 months. Don't forget to set sub-objectives to help you achieve your main objective.

4/ Understanding the context

There are 2 main areas that will help you understand how to reduce your DSO:

• the market in which your company operates
• your customer portfolio and its health

Some markets are highly seasonal. This has an impact on production and sales trends, and often leads to a clustering of receivables over similar periods, which can put your company in difficulty. Identifying the seasonality experienced in your market will enable you to anticipate major discrepancies between cash outflows for production and cash inflows. Define advantageous payment terms with your suppliers, offer customers the option of paying on account, and encourage your sales team to pay for orders rather than just sign quotations.

Customer analysis is too often underestimated and varies enormously from one company to another. Start by analysing your top 10 to 20 customers by sales and check that they pay their bills on time. Keep an eye on their credit score. And don't hesitate to get in touch with their finance or sales team to better understand their prospects for growth and financial health. If you learn, for example, that their margins are under pressure, this increases the likelihood that they'll pull back on supplier payment terms to improve cash flow.

Then analyse the origin of the main overdue and unpaid invoices. Having a clear picture of how your customer portfolio works will help you assess your key market segments. At Agicap, for example, this analysis led us to stop marketing our product to a certain type of customer: the cost of acquisition was difficult, if not impossible, to make profitable, while non-payments were very frequent.

5/ Focus on the front end

The first thing that comes to mind when we talk about reducing DSO is often the collection of unpaid invoices. This preconceived idea leads many companies to neglect the management of customer receivables as a whole, in particular the period between the signing of a quotation and the due date of the invoice.

We recommend that you devote 50 to 75% of your resources to optimising the upstream, i.e. what happens before the invoice is due. Here are a few best practices:

• Train your sales staff. They need to be just as aware of the cash culture as your finance team. Set limits when negotiating payment terms and conditions.
• Modify your sales processes, quotations and purchase orders so that they systematically include down payments.
• Automate invoicing and reminders: from sending the invoice to sending reminder emails or letters. Remember to send an email reminding them of the invoice due date, and improve your preventive reminders. Make sure you're talking to the right person, and consider using another channel if you don't get a response (e.g. phone).
• Reduce your invoicing lead times. Measure the average time from order to invoice and try to reduce it as much as possible. Switch from monthly to weekly invoicing, for example.
• Remember to check customer risk and creditworthiness.

6/ Systematise written reminders

Many companies tend to shy away from reminders for fear of annoying their customers and damaging their business relationship. And yet, in a large proportion of cases, unpaid invoices are the result of an oversight or a bill sent to the wrong person. We recommend that written reminders be sent out systematically, even as a precautionary measure to follow up on point 7, and even in conjunction with a phone call.

The use of software with a generic email address can be a great ally in reminding your customers by email while preserving your commercial relationship, since it will clearly show your customer that the e-mail is the result of an automatic process. Whatever you decide, don't forget to inform your sales team at the same time.

7/ Prepare a process in case of non-payment

• Draw up a clear strategy in the event of non-payment(s), to prevent this from putting your business in difficulty. Solutions do exist:
• withholding the order
• sending a registered letter with acknowledgement of receipt
• increasing the tone of your emails
• appointing a collection agency

In all cases, maintain clear and regular communication with your customer and your sales team to try to understand what is blocking the payment and find a solution.

8/ Digitising the order-to-cash process

This will enable you to centralise all customer information, contacts and invoice status. This will give you better traceability of their payment habits. As far as possible, avoid using paper, or scan printed documents to keep all your information in one place.

9/ Centralising information in a single tool

A logical follow-up to the previous point, having all your data in one place makes it easier to manage and analyse your customer accounts. Bring up information such as the list of customers, their sales managers, contact details for quotations, invoice payments, bank transactions to reconcile invoices, collection actions taken and their impact.

This type of tool provides an analytical view of your accounts receivable, highlighting areas for improvement or customers at risk in dashboards. They can also be used to flag up unpaid invoices, so that reminders can be issued on a regular basis, if they are not already automated.

10/ Ritualise reporting

At least once a month, take the time to produce dashboards that will enable you to assess the impact of your DSO reduction strategy and readjust your objectives or methods if necessary. The person in charge of improving DSO can then create reports highlighting the results of his or her strategy, update key indicators and share them with finance/general management and sales staff.

Don't hesitate to include in these reports a list of the main debtors, the length of overdue periods, their amounts and the progress of collection actions, so that you can deal with them on a case-by-case basis with the sales team.

Bonus: the power of automation

Think long-term: automation will save you precious time now, but even more so in 5 years' time, when it will have grown, attracted more customers, recruited new sales staff, with new products and perhaps more complexity.

Conclusion

Reducing DSO is an essential part of accounts receivable management, which requires a methodical approach and the use of appropriate tools. Agicap has developed a Cash Collection function to recover overdue invoices and manage disputes.