DSO is important because it represents the number days a business holds debt on their books and can impact cash flow.
DSO, or days sales outstanding, is the length of time a business takes to get paid after invoicing. If a business has a high DSO, this may indicate poor invoice management or challenging market conditions where buyers struggle to pay their bills on time. However, this interpretation should be used with care as a high DSO can also represent completely the opposite position. For example, it may be caused by buoyant market conditions and strong credit management, where a successful business is able to offer lengthy payment terms to its customers.
Reduce DSO, increase cash flow
Businesses with the lowest rates of DSO should correspondingly have the strongest levels of cash flow. Businesses that demand payment up front will have access to that cash immediately. On the other side of the transaction, businesses that fail to pay their invoices in a timely manner may do so in order to benefit their own cash flow.
Businesses that have to wait to be paid, face increasing levels of risk; the longer the wait the higher the risk of payment default. This is sometimes called the ‘horizon of risk’, where the bigger the horizon, the more chance there is for something to go wrong.
Can a long DSO indicate healthy client relationships?
Interestingly, a long DSO does not automatically indicate a business that is struggling, but can also represent businesses that have strong relationships. For example, a business with strong cash flow that may be protected from payment defaults by credit insurance, may choose to offer long payment terms to a customer to support their customer’s liquidity and enable ongoing trade. The decision to support their customer may be built on an understanding of their customer and the market they are operating in. Businesses that have good customer communication and strong relationships are often more likely to operate flexible payment terms that are responsive to each other’s needs and create a mutually beneficial trading environment.