What Factors Influence Days Sales Outstanding?

It’s essential for your collection efforts because it’s tied to your liquidity. Your DSO determines the efficiency of your payment terms, the amount of cash flow at any given time and your sales and payment times. 

There are a couple of ways to calculate DSO. The first method is simple and goes like this.

(Accounts Receivables at the end of a period divided by total value of credit sales/gross revenue) x number of days in the period = DSO

As an example, your gross revenue could be $1 million and your AR at the end of a period is $100,000. When you multiply that by 365 days, your DSO is 36.5 days. In other words, it took you 36.5 days, on average, to get paid.

While this first method is quick, it’s not the most accurate DSO calculation and doesn’t take seasonality into account. That’s why the second countback method produces the most accurate results and is more complex. (You can see an example of it here). 

Not all DSO ratios are created equal. It varies depending on the industry. 

A high DSO indicates that a business is taking longer to be paid because of delays. This may be an initial indicator of a potential cash flow problem.

On the other hand, a low DSO indicates that a company has an efficient collection process. According to Investopedia, a DSO that’s under 45 is generally considered to be low. This could be tied to the payment terms of Net 30 - so any payments that take less than 30 days to be collected demonstrate tremendous efficiency or are simply the sector standard. 

E-commerce and retail tend to have a low DSO of 7 - 30 days because those businesses are used to moving and selling products quickly. Manufacturing businesses could have a DSO of 60 or higher because of the longer lead times for developing and shifting products. It’s been said that transportation and logistics companies have an average DSO of 52 days. 

Over the past few years, DSO ratios have tended to fluctuate among recession woes and interest rate hikes. This has caused DSO scores to rise in industries like engineering, healthcare and personnel services. 

Another symptom of market volatility is buyers having to tighten their belts and customer payment behavior is affected. They may delay payments or stop purchasing altogether until goods and services become more affordable.

The recession within the logistics industry has been especially hard. One example is Convoy Inc, which had to file for bankruptcy and we can imagine their DSO being dramatically impacted over the course of months. Co-founder Dan Lewis said the company was trapped in “the middle of a massive freight recession and a contraction in the capital markets. This combination ultimately crushed our progress at the same time that it was crushing our logical strategic acquirer — it was the perfect storm.”

So, it’s always worth staying on top of the most important KPIs in your sector that impact cash flow.

Inaccurate invoices with missing information. Not following up on outstanding invoices. A lack of late fees in contracts. All these factors contribute to customers delaying payment, which leads to these consequences:

• Cash flow issues and revenue loss
• Wasted time and effort chasing payments and drain on resources
• Increased operational costs in having to print more invoices or bring on more labor
• Cost of carrying capital
• Exposure to compliance risks and legal penalties

It’s a given that most businesses will experience revenue fluctuations month to month (i.e. year ends might show a big spike). These peaks and valleys will make cash flow seem higher or lower and impact DSO monthly or annually.

Bear in mind that monitoring DSO shouldn’t just be relegated to revenue or done in isolation. This is just one of many factors that could be a potential reason for a higher DSO. It’s worthwhile to compare it with other metrics like Delinquent Days Sales Outstanding (DDSO) and monitor the collections process.

AR disputes are linked to invoice accuracy - if a customer receives inaccurate information they are less likely to pay on time. Plus, this could escalate into legal action and time and resources are wasted on settling the dispute.

You can reduce the number of AR disputes by having a more streamlined invoice management process. This involves using automated technology that sends accurate invoices on time, therefore lowering DSO.

To return to our point about customer payments, certain sectors have struggled with paying on time and industry trends have moved towards higher DSO ratios. One example is retail, as discussed in our Financial & Bankruptcy Outlook report. 

A business that stood out in the report is Stein Mart, which had a bad case of delinquency (91+ days) for all outstanding bills from May to October 2023. Our data also showed that the company’s Days Beyond Terms (DBT) was 105 in October 2023. What this meant was that its customers were waiting over three months to receive their first payment. 

Generally speaking, it’s preferable to lower DSO and revenue fluctuations are important here too. In this context, you’ll want to consider how to bring in revenue as quickly as possible and there are several ways to do this:

• Cash flow forecasting: Take stock of sales volume, ROI metrics and other essential data points to figure out what collection strategies will be the most efficient. 

• Improve your payment terms: Negotiate with suppliers and customers with payment terms e.g. if you’ve been doing net 60 could you change it to net 30 to speed things up?

• Add incentives: Try adding early bird offers or discounts if a customer pays within a certain time frame. For example, create an offer where if a customer pays in 7 days they’ll get a percentage off the final price. Or, add late fees of 5 - 10% and increase the number based on the amount of days that go by without payment.

Removing as much friction as possible in your AR process is key to lowering DSO. A sure-fire way to do that is to have a robust technology stack that will automate everything. Here are some additional suggestions:

• A vendor-managed inventory system: VMI solutions provide users with more inventory control and payment policies. Revenue and cash flow data can be monitored and invoices sent automatically.

• An electronic data interchange system: EDI software helps to integrate different supply chain channels into an existing ERP system. It bridges the gap between external channels and internal systems so invoices can be processed faster and improve DSO numbers.

Another factor that can’t be overlooked with DSO is credit risk. Whether it’s vetting new suppliers or existing customers, reviewing a company’s business credit report is essential to protect your business from financial risks. You should review the business credit report before agreeing to work with any customers and suppliers as you’ll want to know if they’re a reliable payer, how long it typically takes to pay their bills, if they have a large number of legal filings that are draining their cash flow, among other points. Don’t assume that everything is above board and grant the business payment terms.

Imagine what could happen if you don’t do this. If you sign a contract with a new customer without running a credit check on them, you could end up paying the price down the line. How? Let me explain. Your new customer may run through their cash too quickly or they could have taken on too much debt at high interest rates. If there isn’t enough income and cash to sustain the business, it become tough for them to pay their bills on time – leaving you with past due invoices that haven’t been paid in months.

The reality is that every company needs customers and revenue to grow and scale. Josh Simon, Global Risk & Receivables Director at JAS Worldwide, knows this is the reality of the environment he works in. “At the end of the day, we’re always looking for a way to get to a ‘yes’ with a new customer, whenever possible. The more customers we can sign on, the more revenue we can generate and the stronger our cash flow will be.”

But getting to a ‘yes’ was proving difficult with other credit risk providers we used in the past. Creditsafe’s fresh investigations feature has been immensely valuable for us, as it means we won’t be left in the dark about a potential customer’s financial health, payment behaviors, timeliness of paying bills, legal filings and compliance violations. Not only has the fresh investigations feature been a financial benefit and protected us from unnecessary losses, but it has also given us a competitive advantage.”

The lesson here is that you have to dig deeper into a company’s financial history. You can’t settle for surface-level metrics like credit scores and limits, as Bill James, our Enterprise Sales Director, points out:

“I always tell our customers to use credit limit as a guide and not the gospel for their decisions. It’s important that they get the full picture into a customer’s financial strengths and weaknesses. The sum of all parts is greater than these two data points alone. They should then use the full data picture to make informed decisions about how much credit to extend.

Now if you’re considering extending more credit than the recommended limit, you’ll want to look at their trade payment history. How are they paying their bills? Are they paying on time or is it typical for them to pay over 15 days past the payment terms? Do they owe a large amount of money? Has their DBT score dropped significantly in recent months? Look at all these metrics together and follow that trail.”

A business that took this lesson to heart was JAS Worldwide, a global logistics leader based in Atlanta. The company recognised DSO as an important Accounts Receivables metric and needed to find a way to lower it. By using our credit risk and intelligence platform, JAS Worldwide managed to lower its DSO by 33%.

Josh Simon, Global Risk & Receivables Director at JAS Worldwide, said, “Managing credit risk globally is no easy feat. We have built a robust strategy that involves analyzing and measuring our risk and AR performance across over 60 key metrics. These include reducing our DSO, the total number and dollar value of late invoices, open AR disputes, billing timelines and adherence to credit limit, just to start. While we have seen quantifiable improvements in certain areas, that’s not all we consider when evaluating how useful Creditsafe is to our business.”