How can you use days sales outstanding and days payable outstanding to improve cash flow? (2024)

DSO is the average number of days that your accounts receivable (AR) remain outstanding before you receive payment. It reflects how efficiently you are converting your sales into cash. A high DSO means that you are waiting too long to get paid, which can reduce your cash flow and increase your financing costs. A low DSO means that you are collecting payments quickly, which can boost your cash flow and reduce your dependence on external funding. To calculate your DSO, you can use this formula: DSO = (AR / Total Credit Sales) x Number of Days in Period For example, if your AR at the end of the month is $100,000, your total credit sales for the month are $300,000, and the number of days in the month is 30, your DSO is: DSO = ($100,000 / $300,000) x 30 = 10 days

DPO is the average number of days that your accounts payable (AP) remain outstanding before you make payment. It reflects how effectively you are managing your expenses and obligations. A high DPO means that you are taking advantage of the credit terms offered by your suppliers, which can improve your cash flow and working capital. A low DPO means that you are paying your suppliers too soon, which can reduce your cash flow and working capital. To calculate your DPO, you can use this formula: DPO = (AP / Total Credit Purchases) x Number of Days in Period For example, if your AP at the end of the month is $50,000, your total credit purchases for the month are $200,000, and the number of days in the month is 30, your DPO is: DPO = ($50,000 / $200,000) x 30 = 7.5 days

In order to optimize your DSO and DPO for cash flow, you need to balance two objectives: maximizing your cash inflows and minimizing your cash outflows. This requires reducing your DSO as much as possible and increasing your DPO as much as possible without damaging customer or supplier relationships. To reduce your DSO, you can offer discounts or incentives for early payments, set clear payment terms and policies, invoice customers quickly and accurately, follow up on overdue accounts, and utilize online payment methods or automated reminders. To increase your DPO, you can negotiate longer payment terms or flexible schedules with suppliers, prioritize payments based on urgency and importance, consolidate invoices and payments, and use electronic funds transfer or credit cards.

To measure your cash flow performance, you can use another metric called the cash conversion cycle (CCC). This metric shows how long it takes you to convert your inventory into cash. It is calculated by subtracting your DPO from the sum of your DSO and your days inventory outstanding (DIO). The DIO is the average number of days that your inventory remains in stock before you sell it. A lower CCC means that you are generating cash faster and more efficiently. A higher CCC means that you are tying up more cash in your operations and may need more financing. To calculate your CCC, you can use this formula: CCC = DSO + DIO - DPO For example, if your DSO is 10 days, your DIO is 20 days, and your DPO is 7.5 days, your CCC is: CCC = 10 + 20 - 7.5 = 22.5 days

To benchmark your cash flow performance, you can compare your DSO, DPO, and CCC with your industry averages, your competitors, and your historical trends. This can help you identify your strengths and weaknesses, set realistic goals, and track your progress. You can also use ratios such as the current ratio, the quick ratio, and the operating cash flow ratio to assess your liquidity and solvency. These ratios measure how well you can meet your short-term and long-term obligations with your available cash and assets.

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