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Given that accounts receivable (A/R) are essentially zero interest loans extended to customers, one might be forgiven for considering credit sales a necessary evil. Maybe one day crypto-currencies like Bitcoin will replace all other forms of payment, but in the meantime many companies have a ton of cash tied up in receivables. So how evil is your A/R?

 

According to a recent D&B study on payment practices in the US, only 53% of companies paid their suppliers within the due date.  The remaining 47% were late with 38% of companies paying within 30 days of the due date and the remaining 9% paying over 30 days late. Interestingly, larger companies are the worst offenders with only 10% paying within the due date.

 

How long does it take your company to turn credit sales into cash?  According to NAW’s Institute for Distributor Excellence, the typical distributor’s Days Sales Outstanding (DSO) is 46 days. As one of three measures required to compute a company’s cash conversion cycle, DSO is key in evaluating financial health.

 

Let’s review how DSO is calculated with an example using a monthly timeframe.  Company XYZ made $10.5 million in credit sales in January. At month end, their A/R balance is $12 million. There are 31 days in January, so Company XYZ’s DSO for January is a little over 35 days: 31*( $12,000,000 / $10,500,000 ) = 35.43

 

A more precise calculation of DSO would involve using the average accounts receivable in January rather than the balance at month end. If your company experiences seasonal business cycles, I recommend a yearly timeframe. As an alternative, trend the DSO by month {period} and compare the DSO of any given month to the same month of the prior year.

 

Assuming that collection policies are in line with industry norms, if your company’s DSO is higher than industry average then finding the underlying causes may surface performance improvement opportunities beyond collection activities. Supposing that product quality is not an issue, all business processes falling under the order-to-cash cycle need to be examined.

 

Evil A/R is a threat to cash flow! Fortunately you don’t need superpowers to tackle this villain.


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