DSO can be a difficult AR metric to analyze and understand. It can be misinterpreted because of seasonal sales impacts and large swings in sales due to sales promotions, new product introductions and changes in business conditions. DSO can also be skewed by a change in mix and weighting of different customer payment behavior types. Recognizing your customer’s payment behavior can help you to manage and decrease DSO.
Broadly speaking there are three types of customer payment behavior – early, on-time and late.
Early Payment Behavior
An increase in early payment behavior will decrease DSO.
Customers pay early for several reasons including:
- Cash discount incentives with terms like 2% 10, Net 30 Days, can be significant incentives for early payment to customers with the resources to do so. In our example, the opportunity cost of an approximate 36% return on an annualized basis is a very attractive alternative for the use of cash.
- Customers bumping up against their credit limit may opt to pay outstanding invoices early to keep orders flowing on an uninterrupted basis, if they are unable to increase their credit limit.
- Customers with poor payment histories may be required to pay for orders in advance.
If your DSO begins to increase over time, the change may be the result of fewer customers paying early due to:
- A smaller number of customers taking cash discounts.
- Fewer orders paid in advance for credit reasons.
Things you should check to see if action is required to stem and reduce the increase in DSO would include:
- Cash discount – Is the discount you offer competitive for the industry you are in and the level of interest rates?
- Credit period – Is the credit period you offer too generous and is it competitive?
- Credit standards – Are your credit standards too lax and are they competitive?
On-Time Payment Behavior
If your DSO is roughly the same as the credit period you offer and you don’t have a cash discount option, then you are in a state of equilibrium between your credit terms and sales needs. DSO will go up or down with the proportion of your customers that pay on time.
Should you fall out of equilibrium either way, take a look at your credit standards and credit terms and adjust accordingly to bring DSO back in equilibrium with your financial and commercial needs.
Late Payment Behavior
An increase in late payment behavior will increase DSO. If late payment is a persistent problem, you may need to tighten credit standards and terms and/or offer a cash discount to reduce DSO.
Customer payment behavior can tell you why DSO is changing and provide direction on what actions should be taken to manage and control DSO. It can help you reduce DSO and meet your AR KPIs.
Reporting and analyzing customer payment behavior is very difficult unless you have the technology available in automated accounts receivable and collections. With automation your AR team will have the resources to stay ahead of the curve on DSO.
The key to successfully automating accounts receivable and collections is to work with an experienced software partner.
Lockstep Collect is a market leader in cloud-based credit and collection platforms. Lockstep Collect can help you implement the technology applications you need to reduce and control DSO.
If you would like to learn more about how you can benefit from automating accounts receivable and collections, please contact Lockstep Collect at www.lockstep.io.