The most direct way to reduce DSO is to shorten your payment terms.
If giving your customers 30 days to settle your invoice is negatively impacting your cash flow, you could consider asking for it to be settled earlier.
DSO is Days Sales Outstanding, also known as days receivables, and refers to the length of time between invoicing and getting paid. Reducing the length of the DSO can help improve cash flow, reduce the risk of payment default and minimise lost interest.
DSO reduction strategy
You can reduce your DSO in a number of different ways. The most appropriate approach for your business will depend on your sector and the relationship you have with your customer.
Do you need to reduce your DSO?
The first step in your DSO reduction strategy is to consider whether you actually need to reduce your DSO. Average credit terms vary across sectors. For example the agri-food and fuel sectors usually require the shortest payment terms, normally less than 30 days, where the finance sector can tend to be quite long, often more than 90 days. If you shorten your payment terms so that they are significantly tighter than your competitors, will you become less attractive to customers and prospects? If your cash flow can comfortably accommodate the average payment terms for your sector, it may be best if you don’t shorten your terms. Payment terms that are significantly shorter than your sector’s average could make you less attractive to trade with and may even project an image suggestive of a company with cash flow issues.
Could credit insurance impact your DSO?
Businesses that operate with a credit insurance policy often find that they are paid more quickly than other suppliers. This is because most credit insurance companies, including Atradius, assess the creditworthiness of a policy’s customers. If your customer wants to build a good credit score in order to be granted favourable credit terms in the future, they will need to demonstrate a favourable history of on time payments. As a credit insurance policy holder, this works in your favour as your customers are likely to want to demonstrate their creditworthiness. What’s more, as soon as an invoice becomes overdue, a reminder letter or telephone call from a credit insurance company can often carry more impact and may help businesses to keep their DSO to a minimum.
Can discounting help reduce DSO?
Offering a discount for early payment can encourage prompt payment by customers and result in a lowered DSO. It is a technique successfully used by many businesses exporting throughout the world and can be very attractive for potential customers in a competitive market. Two areas to monitor, however, include your own cash flow (can you afford to discount?) and customers that may try to access the discount without actually paying early.
Can a flexible approach to DSO promote improved liquidity?
You may find that a flexible approach to your credit payment terms is best for both you and your customer, where you lengthen and shorten the terms according to need. This can work particularly well when you have a healthy customer relationship and a mutually agreed approach to managing and promoting liquidity in both businesses.
Is good communication the key to reducing DSO?
Good communication with your customer is arguably the most important tool you have for managing DSO. Late payments can have many different causes, including a mistake in invoicing made at your end. Strong communications across the whole payments journey, including an early check that everything is ok, can help catch mistakes or prompt negotiations such as staged payment plans should your customer be experiencing cash flow problems. Good communication will help foster a strong relationship and help you to better manage DSO.
Is it important to reduce days sales outstanding?
The longer an invoice is left unpaid, the greater the risk of payment default, especially in terms of export credit. In this respect it is important to reduce DSO. However, if your payment terms are too short, you may lower your competitiveness in the market and risk being seen as having liquidity issues. Assess the average payment terms of your market and, if your cash flow allows, position your own terms within this. As long as your credit terms don’t put pressure on your business, it is not important to reduce your DSO. To find out the average payment terms for your market, see the Atradius Payments Practices Barometer, which publishes payment trends in regions, countries and sectors.
Two areas that can support your business with a strong foundation for your credit terms are customer relations and credit insurance. Strengthen your relationships with your customers. This can be mutually beneficial and may help trade flow more smoothly. Explore credit insurance, it could positively impact your DSO and will help protect you against the risk of bad debt.