As a small business owner, managing your accounts receivable (AR) is crucial to maintaining a healthy cash flow. Three key metrics that can help you understand the health of your AR are Best DSO, Best Possible DSO and Average Days Delinquent.
What is Best DSO?
Days Sales Outstanding (DSO) is a commonly used metric to measure the average number of days it takes for a business to collect payment after a sale has been made. A low DSO indicates that the business is collecting payment quickly, while a high DSO indicates that the business is taking a longer time to collect payment.
Best DSO is the ideal DSO for your business based on your industry and payment terms. It is calculated by taking the average payment period for your industry and subtracting your payment terms. For example, if the average payment period for your industry is 60 days and your payment terms are 30 days, your Best DSO would be 30 days.
Why is Best DSO important?
Best DSO helps you understand how quickly you should be collecting payment based on your industry and payment terms. If your DSO is higher than your Best DSO, it may be an indication that you need to improve your collections process, renegotiate payment terms with your customers, or take other steps to improve cash flow.
How to calculate Best DSO?
To calculate Best DSO, use the following formula:
Best DSO = Average payment period for your industry - Your payment terms
What is Best Possible DSO?
Best Possible DSO (not to be confused with Best DSO) is a metric that indicates the lowest possible DSO that a company can achieve based on its customer payment behavior. It is a theoretical value and assumes that all customers will pay their invoices on the due date or earlier. It provides an upper limit to what a company's DSO should be, given the credit terms offered and the historical payment patterns of its customers.
Why use Best Possible DSO?
This metric is useful for companies to understand the minimum DSO they can aim for and to set goals for their accounts receivable management. By using Best Possible DSO, businesses can identify areas where they can improve their collections process and reduce their DSO.
How to calculate Best Possible DSO?
To calculate the Best Possible DSO, companies need to gather data on the due dates of their invoices and the average time it takes for customers to pay. They can then calculate the average time between invoicing and payment and use that value to determine the Best Possible DSO.
For example, if a company's average payment time is 30 days and they have invoices with payment terms of net 30, their Best Possible DSO would be 30 days. If the company's actual DSO is higher than 30 days, it indicates that they have room for improvement in their collections process.
The formula for calculating the Best Possible DSO is:
Best Possible DSO = (Total Accounts Receivable / Total Credit Sales) x Number of Days in the Period
Where:
- Total Accounts Receivable: The total amount of outstanding accounts receivable as of the end of the period.
- Total Credit Sales: The total amount of credit sales made during the period.
- Number of Days in the Period: The number of days in the period for which you are calculating DSO. This is typically 30, 60, or 90 days.
What is Average Days Delinquent?
Average Days Delinquent (ADD) is a metric that measures how many days past due your receivables are on average. It is calculated by taking the sum of the number of days each invoice is past due and dividing it by the number of invoices in your accounts receivable.
Why is ADD important?
ADD helps you understand how long it takes for your customers to pay their invoices on average. If your ADD is high, it may indicate that you need to improve your collections process or take other steps to encourage your customers to pay on time.
How to calculate Average Days Delinquent (ADD)?
To calculate Average Days Delinquent, use the following formula:
ADD = Sum of the number of days each invoice is past due / Number of invoices in your accounts receivable
To calculate ADD, you need to know the total number of past-due invoices and the total number of days that those invoices were past due.
For example, if you have 10 past-due invoices and they are overdue by a total of 100 days, the ADD would be:
ADD = 100 / 10 = 10
This means that, on average, your customers are paying their invoices 10 days late.
In conclusion, Best DSO, Best Possible DSO and Average Days Delinquent are important metrics that can help small business owners manage their accounts receivable and improve cash flow. By understanding these metrics and taking steps to improve them, you can ensure that your business stays financially healthy and continues to grow.
