According to the upcoming Receivable Savvy 2017 Perceptions Study – Analysis of Invoice-to-Cash practices and preferences of supplier organizations, 90% of respondents indicated that getting paid faster was the most important issue when submitting invoices. It stands to reason that if most supplier organizations are focused on getting paid faster, then dealing with late payments is of equal importance.
Late payments not only cause personal anxiety; they negatively impact a company’s KPIs. For example, when calculating Days Sales Outstanding (DSO), many suppliers stop at identifying that specific number with the thought of simply reducing it. The organization would be better served by also understanding the financial cost associated with each of DSO.
For an organization with annual sales of $60 million, reducing DSO by one day can result in a savings of $1,447 per day or $528,155 annually.
By incorporating invoice automation, electronic invoicing, accepting electronic payments instead of paper checks, and automating the cash application process, supplier organizations can shave anywhere from 5 to 10 days from their DSO. Here is how an organization can save $1,447 by simply shaving one day off DSO.
We can use the following numbers as examples for monthly or annual DSO:
- Monthly Sales: $5,000,000; Annual Sales: $60,000,000
- Accounts Receivable in a Month: $1,500,000; in a Year: $18,000,000
- Days in a Month: 30; in a Year: 365
(Accounts Receivable / Annual Sales) x Days Per Year
($13,200,000 / $60,000,000) x 365 = 80.3 days DSO
Now that we’ve calculated DSO at 80.3 in our example above, we can now determine how much it costs a company to carry those receivables. In other words, we can determine how much interest a company would pay per day and multiply it by the average number of days it takes to collect those payments. To determine this, three pieces of information are needed; the company’s DSO (which we’ve identified as 80.3), the total annual receivables and the interest rate (the interest rate could be based on the prime rate or the interest on a line of credit). For this example, the numbers we’ll use are as follows:
- Company DSO: 80.3
- Total annual receivables: $13,200,000
- Interest rate: 4%
The cost for a company to carry those receivables would be calculated as follows:
( (Total Annual Receivables x Interest Rate) / 365) ) x DSO
( ($13,200,000 x 4%) / 365) x 80.3 = $116,160
In this example, it costs this company $116,160 in interest every 80.3 days, $528,155 annually or $1,447 per day to carry customer receivables. As one can see, when supplier organizations lower their DSO, not only do they get paid sooner, they pay less in interest to carry those receivables.
Ernie Martin is Founder and Managing Director of Receivable Savvy. He brings over 25 years of experience in financial supply chain management, marketing and communications and draws upon his extensive experience to share knowledge and best practices with AR professionals. His resume also boasts time at several well-known brands and companies such as Tungsten Network, Delta Airlines, CIGNA Healthcare and Georgia Pacific as well as a number of years as an independent consultant.