Rarely are the owners of small and medium-sized companies aware of the high costs they incur due to late payment of their outstanding receivables. In times of low interest rates, they usually only have their bad debts in mind. In this article, we will show you how to identify the costs of late payment and thus determine the potential savings that effective, automated, targeted and, above all, customer-oriented receivables management can bring.
1) Calculating Days Sales Outstanding
Only a few company managers know their Days Sales Outstanding (DSO). However, they should not only know them, but also keep an eye on them at all times. After all, they are a particularly important indicator for managing and improving cash flow.
The DSO indicates for a company how long it takes customers on average to pay their invoices. Especially those who, like so many small, medium and even larger businesses, frequently grant merchandise credits should always monitor the DSO as a central indicator. It allows him to quickly and realistically assess his own ability to receive payments on time.
It can be calculated as follows: Trade receivables are set in relation to sales. The whole is multiplied by the number of days in the period under consideration. The usual period is one month or 365 days for a whole fiscal year.
2) Identify potential for interest savings
If a company introduces an innovative software system for receivables management, it will succeed in permanently reducing DSO. Let's assume a company that generates sales of trade or merchandise credits amounting to 15 million euros. If it achieves its goal of reducing its previous DSO from 60 to 50, it will benefit from a significant interest saving: because it will continuously save the interest costs that it would otherwise have to factor in for financing from its principal bank (five percent in this example). To calculate the savings, we multiply the sales of trade or merchandise loans by the current interest rate, divided by 365, plus the improvement in the DSO:
The best way for companies to do this is to compare themselves with similar companies: If the DSO is far above the average for their industry, it is important to take countermeasures. According to Euler Hermes, the industries with the highest DSO in Germany are construction, electronics and mechanical engineering with more than 80 days - compared to a German average of 65 days.
A low DSO means that customers pay quickly. This means that little capital is tied up in receivables, so companies can enjoy freedom for investment and high liquidity. The lower the DSO, the lower the default risk as a rule. On the other hand, a high figure shows that it takes a long time for their customers to pay their invoices. This results in a high level of receivables, a strong capital commitment and therefore often hardly any scope for investment. Effective receivables management is the decisive way to reduce DSO.
Late payments incur late payment costs for the company; conversely, faster payments can save the company annual interest costs:
15 Million Euro * 0,05 / 365 * 10 = 20.548 Euro
Calculate the cost of late payments in different scenarios.
3) Identify potential for increasing cash flow
In addition, a reduction in DSO causes cash flow to increase because less financial resources are tied up in trade receivables. And companies can now use these for investments or other important projects. In our example, improving DSO by 10 days has a considerable effect. The freed-up cash flow (cash flow effect) is calculated as follows: Trade or merchandise credit sales are multiplied by the improvement in DSO and divided by 365.
In our company example, there is a significant increase in free cash flow - and this also increases the scope for new or other projects:
15 Million Euro * 10 / 365 = 410.959 Euro
4) Benefit from more efficiency
At last, employees tracking open items have more time for complex cases. In addition, receivables management gains speed and efficiency when it is automated. This not only ensures further savings, but also opens up new perspectives for the company.