As credit and collection professionals, we’re always under pressure from upper management to get the DSO down. Many years ago when I was just getting started, I remember learning that DSO is often determined on a monthly, quarterly or annual basis.
Not to bore you but if I recall correctly, DSO can be calculated by dividing the amount of accounts receivable during a given period by the total value of credit sales during the same period, and then multiplying that result by the number of days in the period measured.
- Total Credit Sales in February: $500,000
- Total A/R outstanding at the end of February: $400,000
- Number of days in February: 28
- DSO for February is: (400,000 / 500,000) x 28 = 22.4 days
What this means is that all the credit sales in February will turn into cash in about 22.4 days, which is generally considered quite good.
Conversely, if the total A/R outstanding at the end of February were $700,000 then the DSO would be: (700,000 / 500,000) x 28 = 39.2 days, and depending upon the industry, competition and many other factors, this could be considered on the slow side.
But this article is not about how to calculate Days Sales Outstanding but how to Deal Strategically with Outstandings. You see, behind every figure is a method that needs to be implemented so that we can actually refine the figure in question. Let me share a few points on how to deal strategically with outstanding accounts.
1) Understand the make up of the customers that represent your A/R – For many companies, A/R (like inventory) is comprised of the following kinds of customers:
- Fast moving
- Medium fast moving
- Slow moving
- Obsolete (those who end up bankrupt)
In addition, slicing and dicing your A/R based upon the following sales ranges:
- Less than $5,000
- Between $5,000 – $10,000
- Between $10,000 – $25,000
- Between $25,000 – $50,000
- Between $50,000 – $100,000
- Over $100,000
would help to understand which kind of customer at what level of A/R the credit or collection manager needs to focus on.
For example, easily identifying which customers are slow moving and between $50,000 – $100,000, would be a very strategic way to stay on top of these particular accounts before they might possibly move into the delinquent category. This is especially important since the larger the customer’s A/R balance, the greater the impact to Days Sales Outstanding it will have.
2) Review sales and payment terms on new accounts – You’ve no doubt heard the expression, “to nip it in the bud,” and this is so true when the sales department hands the credit professional the new customer application, along with the first order. Although there may be a lot excitement over the order, especially a large one, making sure the customer understands the sales and payment terms from the get go, along with any other details, will hopefully help to direct this new customer into the fast moving category.
3) An organized approach to delinquent accounts is imperative – Unfortunately, with the way the world works, conditions inside and outside of a customer’s control will often impact even the best paying customers, and cause them to become delinquent. Who will initially contact the customer and how, over what period of time, before having to escalate the matter upwards, etc., should all be written down in a credit manual or policy, and updated on a periodic basis.
4) Knowing when to let go – As Kenny Rogers sings, “You have to know when to hold ’em and know when to fold ’em.” When customers remain in the delinquent category and show little or no sign of either having the will or the capacity to pay, it’s time to place it with a third party professional. This will not only let you concentrate on other accounts but also help you maintain a reasonable DSO level as well.
This article was edited by Steven Gan.