Your Secret Weapon to Better Cash Flow: The Days Sales Outstanding Ratio

Cash is king, they say. Well, this adage isn’t wrong when it comes to startup survival. Think about it: What’s one thing nearly all businesses that don’t survive have in common? Ultimately, they run out of cash. 

Moral of the story? You should pay close attention to drivers that will help you improve your cash flow/cash position. And we’re here to talk about an overlooked, but critical metric: Days Sales Outstanding Ratio.

Your Days Sales Outstanding Ratio - or DSO - is critically relevant to your cash position. Days Sales Outstanding is the number of days it takes your business to get paid by your customers for the services that you perform. A high DSO number means that you aren’t getting paid fast enough, and therefore you have to rely on other funds of cash (e.g. Line of Credit, equity) to keep your day-to-day a float. 

If you have a high DSO, you are effectively giving your customers an interest free loan while needing to figure out other ways to pay your employees and suppliers. Not an enviable position to be in and one that is ultimately going to strain your cash flow. 

A low DSO means you are turning your services into cash quickly, which puts you in a better position to then reinvest that cash for growth.

In summary, strained cash flow increases your risk for startup failure, and effectively managing your Days Sales Outstanding reduces your risk.

How To Calculate Your Days Sales Outstanding

Managing your DSO starts by knowing your numbers. The good news is you don’t need to be a math guru to find out your DSO. As long as you have access to accurate and timely financials, you’re nearly there. Below we show you how to calculate your DSO.

Steps to calculate your DSO:

Step 1

Calculate your Average Accounts Receivable by taking AR at the end of the period plus AR at the beginning of the period and then divide it by 2.

Step 2

Divide this number by gross revenue over the period. 

Step 3

Take this number and multiply it by the number of days in the period. 

Days Sales Outstanding in Action

For example, let’s say Widgets Inc. reported $300,000 AR at the end of June and $350,000 AR at the end of July. They also reported total gross revenue of $500,000 in this period. And we know that there are 31 days in the month of July.

1. ($350,000 + $300,000) / 2 = $325,000

2. $325,000 / $500,000 = .65

3. .65 * 31 = 20.15 days

So in this example, it takes an average of 20 days for Widgets Inc. to get customers to pay once the invoice goes out.

Now here is where the magic begins. No matter your starting point, small changes to your DSO can have a big impact. 

Let’s say that you are able to improve your DSO by 10%. In the example above, we’d be taking our DSO from around 20 days down to around 18 days. This one step alone would add nearly $35k in additional cash generated by your business. Imagine the things you could do with that additional $35k upfront, rather than having to draw that same amount off of your Line of Credit.

Four Ways to Optimize Your DSO

Well, the burning question by now is how can I improve my DSO by 10%? It’s actually quite achievable!

1. Be timely with your invoicing process. 

To the extent that you can accelerate the time it takes each month to get invoices out the door the better you’ll be. Perhaps consider creative ways to incentivize your team to prioritize this process. If you have an outsourced or virtual team managing your accounting and finance function, ask them about their turnaround time to get invoices sent.

1. Accelerate your payment terms.

If you are typically invoicing with 30 day payment terms, consider changing to 15 or 20 day payment terms instead. Just remember: a small change to payment terms can boost your cash flow. 

1. Offer incentives for earlier payments. 

Offer your customers a discount for upfront payment. It’s a win/win for everyone. 

1. Promptly follow-up on outstanding and overdue invoices.

It’s easy to let something like this sit on the back burner. Don’t wait until your receivable balance is way past due – consider reaching out even as that initial due date is approaching. Look for ways to automate this process so that cash does not go unclaimed.

Lowering your DSO may be the thing that keeps you afloat when other uncontrollable factors are not in your favor. So make it your priority to shave 10% off your DSO. You won’t regret it when the cash keeps flowing.