Is Your DSO Too High?

Days Sales Outstanding (DSO) is a metric that measures the average number of days it takes for accounts receivable to be collected. DSO can be calculated by dividing the total accounts receivable during a certain period (e.g. month, quarter, year) by the total credit sales multiplied by the number of days in the time period. Note, there are other more precise ways to calculate DSO but this one is the most widely-used. Best-Possible Days Sales Outstanding (BPDSO) is a related metric that measures what DSO should be if all credit customers paid exactly according to the terms of their invoice. So, for example, for a Government contractor with one cost-type contract, the Government should pay an "adequate" invoice within 30 days. The BPDSO in this case would be 30 days. If payment were received in 40 days, the DSO would be 40 days. The 10 day spread between DSO and BPDSO is where contractors should  be concerned.

The Government is usually pretty efficient in paying invoices (these days). Initiatives designed to assist small businesses has significantly reduced the time it takes for payment to be made - some reports as quickly as ten days. The Government however measures the time it takes to pay an invoice once an adequate invoice is received. And there is the rub. When an invoice does not match contract terms or omits certain required information and/or attachments, the invoice is rejected, payment is delayed and DSO increases. To correct a rejected invoice, involves hours of time from multiple departments to manually locate the missing information needed to "correct" the invoice - causing further inefficiencies within the company.

Some of you might be thinking, 30 days or 40 days, what's the big deal? Eventually we'll get paid. If that's your situation, congratulations. You are in a minority. Most contractors operate with lines of credit that come with interest payments. Adding 10 days over and over and over will result in increased interest payments that impact their bottom lines.  Run DSO metrics periodically and plot the trends. You might be surprised and you might find that a few changes to your billing system can bring down your DSO.