Cash Flow & DSO

Cash is King, or at least it should be, for all businesses – no matter the size. Still, many companies focus on profit, rather than on working capital (cash). Profit is important, but positive cash flow is what keeps the company going. By now, we should have all learned that lesson. A lack of working capital was the primary “cause of death” for many U.S. dot-coms in the early 2000s. The same issue was also the reason for many of the bankruptcies filed during the recent financial crisis. Therefore, the primary focus of any business should be positive cash flow management.

What is Cash Flow? Simply put, cash flow is the movement of money in and out of a business. The goal of cash flow management is to decrease the amount of time it takes to collect cash, while increasing the time interval for disbursing it.

The first step in improving cash flow is to determine why there’s a cash flow problem. Where is cash tied up?

Some potential cash traps include:

  • Cash sitting in non-interest bearing accounts
  • Unnecessary or underused inventory
  • Fixed assets: building, equipment, cars, etc.
  • Loans to officers, employees, affiliated companies
  • Uncollected sales (accounts receivable)

One of the most common cash traps is uncollected credit sales, a.k.a. accounts receivable. The focus of this article is on how uncollected sales can negatively impact your cash flow and how the Days Sales Outstanding (DSO) calculation can give you an inside view of the cash trapped in your accounts receivable.

The Accounts Receivable Cash Trap

Selling on credit is a requirement in today’s economy. Most companies can’t compete domestically or globally unless they can offer credit terms. Unfortunately, too many credit buyers treat credit terms as if they were interest-free, perpetual loans. Their tactic is to drag out payment as long as possible. As a result, many sellers end up with an inordinate investment in accounts receivable tying up their cash flow.

Calculating just how much it costs to carry your receivables is relatively simple. Determine how much interest you would pay per day on your total annual receivables and multiply this by the average number of days it takes you to collect on credit sales (DSO).

Reducing DSO

As you can see, DSO has a tremendous impact on cash flow. Reducing DSO, even slightly, can go a long way toward improving the health of your company.

The next step, of course, is to find ways to reduce DSO. Answer these questions in each area of your A/R management process to find holes that need to be plugged.

Receivables Management

Do you have a collection process in place? Do you adequately follow-up on customer disputes and late pays? Are you measuring performance against goals? Do you regularly review aging reports? Do you have an understanding as to why customers are paying late (i.e. invoice discrepancies, quality issues, etc.)? Have you trained your customers to pay within terms?


Do you have employees focused on collections? Are they well trained? Do they have enough time to follow up on all past due accounts? Have you considered outsourcing part of your receivables portfolio (small balances, specific divisions, etc.) for 1st party collections follow-up? Should you consider using a professional 3rd party collection firm?

Just a small improvement in DSO can go a long way toward improving the health of your company – and a healthy company is in a position to meet the needs of all its stakeholders and customers, making everybody happy.

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