Why DSO is important in debt collection

Another of my interests and roles is the stewardship of our debt collection/credit control module, SunSystems Collect. I have been remiss in not including my thoughts on that area in this blog. Today I was drafting an article for another forum and thought it pertinent to add here.

Days Sales Outstanding (DSO)

DSO is probably one of the most critical performance metrics in the debt collection process. It tells you the average number of days sales still outstanding based on the period of activity assessed. It is worth noting that DSO measures the efficiency of your collections in terms of how quickly the invoices are converted to cash rather than the effectiveness of your collections in terms of what activities result in the best client behaviour.

The most common base calculation is:
[total receivables]
first divided by [credit sales value for the period]
and then multiplied by [number of days in sales period].

SunSystems Collect has a number of algorithms built in which are detailed extensively including work-through examples in the reference manual.

A low DSO is good and means clients pay their invoices in a timely manner, a high DSO means clients pay slowly and quite probably late. A high DSO means the company is using its own cash to fund the business rather than recovering cash owed to it by clients and using that to fund the business. When you go out to replenish product stock (or whatever) it is a far healthier position to be in paying with money from sales than money from your savings.

If the client DSO value is close to the client payment terms then they are behaving well, however if for example the terms are 30 days and the DSO is 60 days then you have some work to do. A low DSO can also be a health indicator for the client - happy clients pay their bills.

There are no exact good and bad values for DSO however there are forums for most industries where membership will include access to common benchmarks, best in class etc. As an example, for some industries if your payment terms are 30 days then a common and reasonably achievable goal is to keep DSO in the low 40's. Best in class would probably be consistently sub 40 days.

Collect also allows you to analyse the DSO over time by various dimensions. So you may want to see DSO trends broken out by account manager, and perhaps also by project or product. Measuring your collections staff by DSO can create a healthy competitive atmosphere where people strive to better eachother in keeping the DSO down for their allocated accounts. When a collector only has time for one more phone call in the afternoon they should perhaps target it at a client that most counts from a DSO perspective.

Some organisations use the value of a single days DSO as the target for sales/account managers to agitate their clients to settle outstanding dues. If each account manager succeeds in reducing your DSO by a day then you will have recovered a meaningful amount of cash back into the business at virtually no cost of sale. For some organisations they discover that reducing their DSO by 10 days is worth more to the business than increasing sales by 10%.

DSO is well worth focusing on for your collections activity.