As we all know, cash flow is the lifeblood of every business. Having sufficient cash can be the difference between success and failure and it is a concern that keeps many small business owners up at night. Accounts Receivable is the largest or second-largest asset of most businesses and reducing the amount of cash tied up in those outstanding receivables — and the associated cost of financing them – will have a positive impact on a company’s cash flow.
Days Sales Outstanding (DSO) is a simple measure of how long it takes for you to collect an invoice. DSO is calculated as:
DSO = (AR Balance / Credit Sales for a time period) X Number of days in that period
For example, a company with $10 million in annual credit sales and an AR balance of $1.5 million would have a DSO of 54.75, as follows:54.75 = ($1,500,000 / $10,000,000) * 365
The annual cost to this company of carrying these receivables is $75,000, assuming financing at a 5% annual percentage rate. Reducing DSO by just one day saves $1,370 in interest and frees up $27,397 in working capital.
Even more substantial reductions are possible by utilizing accounts receivable and collections automation solutions like Anytime Collect Surveys consistently show that the average DSO across all companies is between 40 to 60, although this varies considerably by industry segment and company size.
Research by PayStream Advisors, an industry analyst group, indicates that it is possible to reduce DSO by 10 to 20 percent by investing in collection automation software such as Anytime Collect. In the above example if we cut DSO by five days (9.13%) to 49.75 days then we save $6,849 in interest and generate $136,986 of free cash.
Rather than limiting their search for working capital to loans or investments, business owners should examine the feasibility of improving their internal collections process as a means to obtain cash.
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