The hidden cost of Days Sales Outstanding (DSO)

Many companies are meeting their performance goals but still face cash flow bottlenecks. A key reason? Days Sales Outstanding (DSO). In today’s unpredictable economy, DSO isn’t just a metric—it’s a red flag for financial pressure. High DSO can drive up borrowing costs, limit strategic investment, and strain supplier relationships. More critically, it locks up working capital that could fuel growth or help absorb economic shocks. Simply put, controlling DSO is no longer optional—it’s essential for resilience.

What is Days Sales Outstanding (DSO) and what does it mean for your business?

Days Sales Outstanding (DSO) is a key measure that shows how long it takes a company to collect payment after making a sale on credit. A lower DSO means the company is quickly collecting payments, improving cash flow and freeing up money for other business needs. A high DSO however, indicates that the company is taking longer to collect payments, which can lead to cash flow problems. This may force the business to borrow money or cut back on operations. If payments are delayed too long there is also a risk of not collecting the money at all. Therefore, businesses aim to lower their DSO by improving credit policies, sending invoices promptly and following up on overdue accounts, to maintain healthy cash flow and reduce financial risks.

What causes DSO to change?

Whether it’s increasing or decreasing, there are several factors that can drive changes to DSO. These include:

• Credit policies: If a company loosens its credit policies by offering more generous payment terms or extending credit to higher-risk customers, it can increase DSO. Conversely, tightening credit policies can reduce DSO by ensuring only creditworthy customers are granted payment terms.
• Billing and invoicing practices: Delays or errors in invoices can increase DSO, as customers may take longer to pay if the invoice is incorrect or. Prompt, accurate billing can help reduce DSO.
• Customer payment behaviour: If customers start taking longer to pay their bills or face financial difficulties, DSO will increase. Factors such as economic conditions, industry trends or customers’ financial health can impact payment behaviour.
• Economic conditions: In times of economic downturn or uncertainty, customers may delay payments, leading to higher DSO. On the other hand, a strong economy might encourage faster payments and lower DSO.
• Collection efforts: Companies that actively follow up on overdue accounts and have effective collections processes will likely have a lower DSO. Poor collection efforts or a lack of follow-up can result in higher DSO.
• Industry norms: Different industries have varying payment cycles which can affect DSO. For example, industries with long-term contracts or large transactions may have longer payment periods, leading to higher DSO compared to industries with quicker payment cycles.
• Seasonal fluctuations: Businesses that experience seasonal sales fluctuations might see a change in DSO based on the timing of sales and customer payments. Higher sales in certain months might temporarily increase DSO if customers are given longer payment terms during those periods.
• Change in sales mix: A shift in the type of products or services sold (e.g. offering larger or more complex deals) can lead to longer payment terms, increasing DSO. Alternatively, focusing on smaller, quicker-paying customers can reduce DSO.

These factors can impact DSO in both the short and long term. As a result, businesses need to actively monitor and manage them, to maintain healthy cash flow and efficient working capital management.

DSO and its relationship to other working capital components: Days Payables Outstanding (DPO) and Inventory Days

DSO is closely linked to various aspects of working capital management, particularly to the management of accounts receivable. Since working capital represents the difference between a company’s current assets and current liabilities, accounts receivable plays a key role as a major component of current assets.

DSO is calculated by dividing accounts receivable by total credit sales and multiplying by the number of days in the period. The calculation of DSO provides valuable insight into how efficiently a company converts its credit sales into cash. As it reflects the average time taken to collect payment from customers, DSO serves as an important indicator of a company’s short-term financial health and operational efficiency.

When DSO increases, it can negatively impact working capital, as more funds are tied up in outstanding receivables instead of being available for other business needs. For instance, if a company is taking longer to collect payments, it may need to use external financing or liquidate assets to cover its short-term obligations. This creates a strain on cash flow and can affect the company’s ability to invest in growth opportunities, pay suppliers or meet payroll.

What causes DSO to increase, and the impact of high DSO on business performance?

High DSO can have significant negative consequences for a business. One of the most obvious impacts is on cash flow. When cash is tied up in unpaid invoices for long periods, a company may face difficulties in covering its day-to-day operational expenses, such as paying suppliers, staff salaries or other short-term liabilities. Additionally, a prolonged collection cycle can increase the risk of bad debts, these are debts that may never be recovered.

Furthermore, high DSO can indicate inefficiencies in the credit management process, such as weak credit policies, poor customer screening or ineffective follow-up on overdue accounts. Over time, this can damage relationships with suppliers, increase the cost of capital and potentially lower the company’s profitability.
 

Mitigating payment risks and lowering DSO

Businesses can adopt various strategies to manage mitigate the risks associated with high DSO and lower the number of days sales outstanding:

• Implement strong credit policies: Establishing clear and consistent credit policies is essential. This includes setting appropriate credit limits, offering early payment discounts, and carefully vetting new customers for creditworthiness.
• Improve invoice accuracy and timeliness: Ensuring invoices are accurate and sent promptly after a sale is critical. Delays in invoicing can lead to delays in payment, so making sure that billing is done quickly and correctly is essential.
• Regular follow-ups on outstanding invoices: Setting up automated reminders or assigning dedicated resources to follow up outstanding invoices can help ensure that payments are made on time.
• Offer payment plans: For customers who may struggle to pay in full, offering flexible payment terms or instalment plans can improve cash flow while still securing the revenue.

The role of credit insurance in lowering DSO

Credit insurance is one of the tools businesses use to mitigate the risks associated with high DSO. By securing insurance against potential bad debts, a company can reduce the financial risk of non-payment. Credit insurance allows businesses to protect themselves in case a customer defaults on payment, ensuring they still receive a portion of the outstanding amount.

This insurance not only protects the company from losses but also provides an opportunity to extend credit to customers with more confidence. This can potentially lower DSO by improving the company’s ability to offer more favourable payment terms to customers, knowing they have insurance coverage.
 

The importance of collection agencies in reducing DSO

When internal efforts to collect outstanding invoices fall short, many businesses turn to collection agencies. These agencies specialise in recovering overdue payments and have the experience and resources to chase delinquent accounts effectively.

By outsourcing the collection process, businesses can reduce the time spent on receivables management, allowing internal teams to focus on other important tasks. Collection agencies can help reduce DSO by acting as a third-party intermediary, which can sometimes be more effective in pushing customers to settle their debts.

How we can help protect your business?

Managing DSO is crucial for maintaining a healthy cash flow and ensuring the long-term financial stability of a business. By keeping DSO at optimal levels, businesses can ensure that their working capital remains healthy and that they have the funds available to meet short-term obligations. Strategies such as improving credit policies, automating invoicing, offering payment plans, and using tools like credit insurance and collection agencies can all help to lower DSO and reduce the risks associated with extended payment cycles. By taking proactive steps to manage DSO effectively, businesses can safeguard their financial health and create a more sustainable operational environment.

Get in touch today to explore our tailored solutions designed to protect your cash flow and keep you on track for continued growth.