Higher Euribor rates increase limit fees. Use DSO to optimize cash, which means less cash buffer on a bank account and lower interest fees.
If Central Banks continue to lean toward taming inflation, we face higher interest rates and postponements of investments because of the higher discount rate and internal rate of return (IRR). Prepare for the future and ensure your business runs without the new external funding.
What is the risk in cash forecasting?
Our money is in our bank accounts and open sales receivables (customers' bank accounts).
Customers pay their invoices on the due date only in a perfect world. Predicting customer payments is the most critical part of cash forecasting because paid sales invoices only fund salaries, taxes, and purchase invoices.
You can predict salaries, supplier payments, and taxes on a spreadsheet, but it's slow and sensitive to human errors. Customer payments are hard to predict because customers pay late, and their payment behaviors are sporadic. So this is where the risk comes in.
In practice, the more significant the sales invoice, the bigger the impact on our Cash flow, Cash forecast, and Cash flow risk.
DSO tells the number of days it takes for a customer to pay a sales invoice to you.
Days Sales Outstanding (DSO) is a KPI that tells the number of days it actually takes for a customer to pay a sales invoice. DSO is measured daily using the latest customer payments.
In practice, the more significant the sales invoice, the bigger the impact on our Cash flow, Cash forecast, and Cash flow risk. The same goes for a DSO.
Why monthly DSO based on monthly bookkeeping is misleading?
Sometimes we see DSOs calculated monthly using monthly bookkeeping balances on a Balance Sheet, which is misleading and doesn't say anything about risk. When you see it, KPI is at least one month old and calculated using stale data based on monthly bookkeeping, including accruals and bookkeeping entries. And last but not least: more significant payments have an enormous impact on your DSO, not done when using bookkeeping reports.
How to use DSO in the current market environment with Cash flow risk management?
Controllers in many wealthy S&P 500 businesses with a positive cash flow utilize the dynamics of payment times.
Using dynamics of payment times, they decrease Cash flow risk and improve Cash Forecasting.
Controllers in many wealthy S&P 500 businesses only use a straightforward rule of thumb: keep sales invoice payment time (DSO = Days Sales Outstanding) shorter than purchase invoice payment time (DPO = Days Purchase Outstanding).
If there is a difference in the payment times, cash forecasting problems arise both in sound and hard times. During strong growth, speeding up cash-in is vital due to high burn. During the steady growth, the dynamics of payment times leave more money to pay your investments or loans. And during the downturn, cash is king.
How to use DSO in cash forecasting and cash flow risk management?
The direction of the DSO is always much more important than the absolute KPI value.
A great goal is to improve DSO faster than the industry, earlier DSO, or your DPO (Days of Purchase Invoices Outstanding).
Speeding up DSO can be done in two ways: negotiating payment terms shorter and keeping the late payments in control.
Build your cash engine on short payment terms: negotiate your payment times faster than your DPO. Make sure your finance team is invoicing promptly.
Tips for using DSO for your cash flow risk management
1. Use real-time customer payments to track your DSO and DPO.
2. Set your goal to improve DSO faster than the industry, earlier DSO, or your DPO.
3. Speed up DSO by keeping payment times of sales invoices in control.
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