Entrepreneuer's Playbook: Cash Management & DSO
Note: Running most Fridays in FromGregsHead.com, this is the second in a series of business tips offered by Greg Price. These run Saturday mornings during the BusinessMaker’s Radio Show on FM Newschannel 97.5. Audio files can be found at the PKF Texas Radio/Television page.
In this ever more fragile economy, managing your cash flow may prove to be one of the keys to your Company’s survival. Customers will delay payment in an effort to preserve what little free cash they have. Unfortunately, this can be prove to be extremely painful for your Company, and may lead to your demise.
As an owner/entrepreneur, you are faced with many financial terms. One of the key terms you should become familiar with in managing your business is “Days Sales Outstanding (DSO).” You can calculate DSO by dividing your total annual revenues by 365 to get your average daily sales. Then, take your monthly accounts receivable balance and divide by the average daily sales to get your DSO.
Did you know that a properly designed and implemented cash management process, allowing you to track and collect overdue accountings can have an immediate impact on your cash flow? For example, a three-day reduction in your DSO balances (a very reasonable and achievable target) will generate $5,000 in cash flow for every $1 million in revenue. Thus, a $10 million dollar company should be able to generate $50,000 in cash flow by having a well designed and operating cash management and collection program.
I quickly learned the value of predictable and consistent cash flow when I took my public relations and freelance writing business full-time. I have found that both offering upfront payment incentives and creating disincentives for late payment help facilitate on-time receipt of amounts due. For example, I offer a small percentage discount if clients want to pay for three or six months of retainer services in advance. Conversely, I reserve the right to charge a perecentage penalty fee if payments are not received within 15 days and another after 30 days, of the due date. I have learned from others that implementing one of these elements without the other often is not as effective.