As manufacturers try to navigate the changing work environment, they’re also looking for efficiencies. While several metrics can be put in place to measure success, one way to help your company run more smoothly and keep afloat during tough times is to reduce your days sales outstanding.
Days sales outstanding (DSO) is how long it takes for a buyer to pay an invoice from the supplier. The fewer days your sales are outstanding, the faster you, as the supplier, get paid. A lower DSO improves your cash flow and keeps your business running at its best. However, a higher DSO can hinder your business from growth since your profits aren’t being realized on time. In turn, this slows down the rest of your operations that run your business.
In a perfect world, your customers would always pay you on time, if not in advance. But that is not how it plays out most of the time. So, how can your organization thrive and reduce its DSO? Read on to learn which strategies you should avoid and which you should adopt for long-term gains in 2021.
TRADITIONAL STRATEGIES TO REDUCE DSO
There are some strategies that your organization may have heard of or tried out to reduce its DSO. Although these can work in the short-term, I do not recommend using these as strategies for the long-term. Here’s what they are and why they’re not as effective as you may think:
- Payment reminders: One traditional strategy is sending your customers reminders to encourage them to pay you faster. While this can work, it’s simply not going to consistently lower your DSO over time.
- Incentives: This strategy gives your buyers some incentive to pay their invoices faster. Most incentives come in the form of getting a discount off your service. While incentives can help you get paid faster, using this method can hurt you in the long run since you’re consistently losing money from offering discounts.
- Multiple payment methods: While it’s a great practice to have multiple ways for customers to pay you, it doesn’t necessarily help them pay you faster.
So, if these aren’t the best solutions, then what is? Don’t fret. These next strategies I will reveal can help you save more money, foster positive relationships with your trading partners, and give you more visibility and control as to where your invoices are in the cycle.
INNOVATIVE STRATEGIES TO REDUCE DSO
The best way to truly reduce your DSO over time is to approach your accounts receivables process holistically. Rather than focusing simply on the part where your customers pay you, look at what changes you can make to shorten the time spent getting the invoice prepared, sent, and finally received by your customer into their accounts payable system:
- Go paperless: Paper invoices take lots of manual work on both sides, and too much time to get to your customer. Using paper creates time-consuming steps like preparing the invoice, sending it to your customers, collecting receipts, and getting feedback. Going paperless improves your team’s visibility, increases data accuracy and reporting, and allows documents to be sent and received more quickly, overall lowering your DSO.
- Digitalize your invoice process: If you want to increase efficiency even more, then completely digitalize your invoice process. This means, rather than using mail or email, you can distribute your invoices as true e-invoices that can be imported directly into your customers’ systems. Not only will you get the acknowledgment that the invoice has been received, but you will also get feedback on missing information within seconds instead of days. This significantly shortens your DSO as many of your customers will pay their invoices much faster when received upfront in the complete and correct format.
- Encourage your customers to adopt a digital approach: According to the Billentis 2019 Report, the use of e-invoices is going to quadruple by 2025, making e-invoicing the most efficient way to exchange documents with your business partners. Once both you and your customers digitalize, the entire transaction time will be faster, reducing your DSO.
REDUCING DSO TO IMPROVE ROI
Improved return on investment (ROI) is a result of reducing your DSO. You can easily calculate the impact that reduced DSO can have on your organization by knowing your company’s sales revenue, invoice-to-cash cycle, and weighted average cost of capital (WACC).
Let’s use the following numbers as an example:
- Sales revenue: $500 million
- Invoice-to cash-cycle: 45 days
- WACC: 12%
By adding these numbers together, your working capital to fund cash cycle would be $61 million with a working capital interest cost of $7.3 million.
According to our customer data, moving to an e-invoicing process can improve the cash cycle by an average of approximately nine days. This is because your customer will receive the invoice straight into their AP systems within seconds instead of days.
In addition to reducing the days, what would this significantly improved cash cycle mean for working capital interest savings? Let’s say you send e-invoices that make up 50% of your total sales revenue. By getting paid nine days faster, your company would then realize $739,000 in interest savings alone.
Imagine what your organization could do with the savings it gets from just reducing its DSO!
Managing Director – North America, Pagero
Opinions expressed by contributing authors are their own.