Business is good. Orders and shipments are soaring. But, you are running out of cash to pay suppliers, employees and operating expenses. Sound familiar? You may be caught in a cash trap.
Cash is the lifeblood of business. It is the key component of working capital that you need to run your business. Cash keeps orders and shipments flowing. Without it you are dead in the water – unable to buy material and pay employees and operating expenses. Cash is also the resource you need to invest in and grow your company. Cash is critical, particularly to young fast growing companies that don’t have the ability to borrow to weather a cash squeeze or finance business growth. Lack of cash is the primary reason that many companies fail.
Accounts receivable can suck up the cash you need to operate as your business grows. Expanding DSO can create a cash trap that can be hard to get out of. If you are not careful customers will try to use your company as a financing source by delaying invoice payments. DSO expansion can force you to borrow or delay payments to suppliers. Financing your customers comes with a very real cost either way.
Cost of Financing DSO
The cost of being caught in a cash trap can be easily calculated. Consider the following scenario:
- Annual credit sales – $7,300,000
- DSO – 60 days
- Borrowing Cost – 6%
- Credit terms – Net 30 days
Average daily credit sales are $7,300,000/365 days or $20,000.
The cost to finance one day of sales annualized is $20,000 x .06 or $1,200.
The cost to finance 30 days of sales in excess of credit terms annualized is $1,200 x 30 or $36,000.
Cash trapped in DSO in excess of credit terms is $20,000 x 30 days or $600,000.
Benefits of Reducing DSO
Reducing DSO and getting out of a cash trap reduces borrowing costs and frees up cash needed to finance operations and growth of your business.
Letting customers use your cash instead of their own by paying late can be very expensive and deny your company the vital cash it needs to operate and grow. In a worst case scenario, if the cash trap becomes too big, the result could be bankruptcy.
The best way to reduce DSO and avoid a cash trap is to automate your credit and collections. The money you save from reducing DSO and freeing up cash can quickly return the cost of investing in accounts receivable automation. Companies that automate credit and collections have experienced DSO reductions of up to 10 days.
The key to successfully automating accounts receivable and reducing DSO 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 to automate your accounts receivable and reduce DSO.
If you would like to learn more about how you can benefit from automating your accounts receivable, please contact Lockstep Collect at www.lockstep.io.