How to measure your AR efficiency: DSO, DDSO, and DBT
Before recommending the tactics to improve your company’s Accounts Receivable (AR) and cash flow, it’s beneficial for you to first understand how to measure the performance of your AR. DSO, or days sales outstanding, is an accounting ratio that reports the length of time it takes to convert a sale into cash. Companies monitor DSO because it strongly affects cash flow. For example, a higher DSO generally indicates a business is struggling with cash flow. The lower the DSO is, the quicker a company converts its sales into cash. DSO is calculated on a monthly, quarterly, or annual basis.
On the other hand, DSO isn’t the only way to measure your Accounts Receivable department’s effectiveness, as DSO is often impacted by factors beyond your accounting team. Specifically, fluctuations in sales volume impact DSO—which accounting usually cannot control. Therefore, delinquent days sales outstanding (DDSO) and days beyond term (DBT) are more accurate metrics for determining your AR efficiency.
DDSO calculates the average difference between the invoice due date and the date paid. DBT is the average number of days that delinquent invoices have been overdue. DDSO and DBT both contain delinquent accounts in their equation, and are therefore better indicators of your AR department’s performance.
Ways to improve your company's AR
1) Payment incentives
Probably the simplest way to get paid quicker is by offering payment incentives on invoices. Early payment discounts encourage customers to pay an invoice before its due date. These terms generally come in the format 1% 10 Net 30—which means the payer receives a 1% discount if you receive payment within ten days of the invoicing date, otherwise payment in full is due 30 days after the invoice date.
2) Accept more payment methods
The more payment methods (wire transfer, credit card, traditional check, PayPal, etc.) you are able to accept the better. The speed at which you receive payment and the fees associated with the payment can vary by payment method. However, your customers likely have a preferred payment method. New payment methods are continually being adopted by payers, so accepting payments via more methods allows your business to be flexible and receive funds from customers faster.
3) Automate your invoicing
Electronic invoicing eliminates the obvious delays and costs associated with postal mail, but the benefits of leveraging electronic invoicing are so much greater than that. These automation features also help to reduce manual time spent contacting delinquent accounts. If you can automate your invoicing with a digital solution (also known as e-invoicing), you can reduce human error, bill your customers instantly, and track your incoming payments to gain visibility into your cash flow—all while offering a transparent process for your payers.
Automating your invoicing process also enables scheduled payment reminders to notify your customers about their unpaid invoices via email, text, phone calls, and other communication channels. These solutions can be configured create efficiency in your AR process. For example, you can choose to automatically contact accounts that are the most days outstanding first, making these communications even more impactful to your bottom line.
4) Credit evaluations
Before offering credit to a new customer, it is a best practice to check their credit history to ensure that they have a record of paying bills on time. Additionally, establish clear terms and inform your clients of all the details before any agreements are made. If your DSO is worsening and you want to improve efficiency, consider implementing stricter credit evaluations.
These techniques will increase the efficiency of your AR and improve your company’s cash flow. The more quickly an AR department can distribute invoices along with with impactful payment incentives, multiple available payment methods, friendly automated payment reminders, and clear terms and expectations, the more efficient your AR efforts can be.