Businesses today have a strong tendency to favor Days Payable Outstanding (DPO) over their Days Sales Outstanding (DSO). While having a low DPO has many benefits for your business, such as improved relationships with vendors and increased negotiating power, a high DSO can have devastating effects on your business’s cash flow.
When you focus on lowering your DPO, you are essentially putting the emphasis on paying your bills rather than collecting outstanding invoices. This may make you feel like Santa Claus, but it is not the most effective way to manage your business’s cash flow. But, what’s the point of being jolly if your DSO is through the roof? There’d be nowhere for the reindeer to land.
The lower your DSO, the better – it means you’re collecting payments quickly and efficiently. In turn, this translates to more cash on hand; and in today’s economy, more cash means less borrowing.
A high DSO, on the other hand, could indicate that your business is having trouble collecting payments. This can have a serious impact on your cash flow and might even put you at risk of defaulting on your obligations. Paying bills is important, but not when it comes at the expense of your business.
We need to think of AP as an opportunity to improve our own cash flow instead of feeling good by giving others interest-free loans. If DSO is greater than (>) DPO, then we’re loaning money to everyone but ourselves–and that’s not beneficial for anyone.
While it may seem counterintuitive, focusing on DSO rather than DPO can actually be a more effective use of working capital and help improve your bottom line. Here’s why:
- DSO is a leading indicator of cash flow. By keeping a close eye on your DSO, you can get ahead of any potential issues with collections and take steps to improve your processes before they become a problem.
- DSO is a good way to measure the effectiveness of your collection processes. If your DSO is high, it may be an indication that you need to streamline or improve your collections process.
- DSO is affected by changes in buying behavior. An increase in DSO can be a sign that customers are taking longer to pay invoices, which could be an early indicator of financial distress.
While DPO is still an important metric to track, paying before collecting is the wrong strategy to have. By focusing on DSO, you can more effectively manage your working capital and improve your bottom line.
What do you do if your DSO and DPO are upside down?
If you find yourself in a situation where your DSO is high and your DPO is low, it’s important to take action to improve your cash flow. Some steps you can take include:
- Review your credit policy and terms. Are you offering terms that are too generous? If so, consider lengthening your terms to help improve your DSO.
- Take a close look at your collection process. Is there something you can do to streamline, automate, or improve it?
- Consider offering discounts for early payment. This can help encourage customers to pay invoices more quickly and lower your DSO.
By taking these steps, you can help improve your cash flow and get your DSO and DPO back in alignment.
When it comes to managing your business’s cash flow, DSO is a much more important metric than DPO. While it’s great to be able to take advantage of early payment discounts from vendors, focus on DSO to ensure that you’re collecting payments quickly and efficiently. This will have a much bigger impact on your business’s bottom line.
What else can help? Investing in AR automation. AR automation tools, like Lockstep Receivables, drastically cut DSO, while helping teams become even more productive. Ready to learn more? Sign up for a demo today. Ready to get started with Lockstep Receivables? Schedule a demo, today!