Sales and credit go hand-in-hand in today’s business environment. To get new customers, you have to offer credit terms. And, every credit manager knows that some of those sales will be delinquent or even default causing your company to write them off as bad debt.
Uncollected dollars nibble at your company’s profitability and can become a real threat to the survival of your business. In this economy with low margins and tight credit, businesses need to take AR management more seriously than ever. Even your long standing customers may be struggling and you can no longer take anything for granted.
An essential strategy is to have an internal follow up plan in place that deals with accounts as soon as they go even one day past due. In our Veri-Cheque October Newsletter we offered several tips on how to manage your account receivables effectively.
To keep a close watch on all your accounts, we suggest using a simple formula for working out the Days Sales Outstanding (DSO), a useful management tool to measure the average age of account receivables. It shows both the age, in terms of days, of a company’s account receivables and the average time it takes to turn receivables into cash.
Based on your company’s business cycle, you can calculate DSO from month to month or for longer periods:
Annual – 365 days
Semi-Annual – 182 days
Quarterly – 91 days
Monthly – 30 days
Three pieces of information are required for the calculation:
Your total receivables in the period
Your total credit sales in the period (do not include cash sales)
The number of days in the period
Example on how to calculate your company’s DSO:
If calculating your DSO based on quarterly sales, take your total receivables divided by your annual sales and multiply by 91.
Total Receivables = $1,300,000
Total Credit Sales = $3,000,000
Number of days in period = 91
(1,300,000 divided by 3,000,000) X 91 = 40 days (DSO)
It therefore takes 40 days on average for your customers to pay their invoices.
A lower number of days indicate your company is collecting outstanding receivables quickly. Higher DSO can indicate poor follow up on delinquencies and may result in cash flow problems for your business.
When analyzing your company’s performance, if the trend is for DSO to go higher, it indicates your customers are taking longer to pay their bills. A number of factors can cause this including financial issues on the part of your customers or inefficiencies with your company’s collections department that requires attention.
Many businesses today reduce their financial exposure and count on an extra layer of protection by insuring their accounts against bad debt through Veri-Cheque’s Accounts Receivable Guarantee Program. It’s certainly a very good defensive move for companies looking to stay solvent over the long run. Feel free to give us a call 800-268-3284 to get more information about how we can help your business.