We’ve all heard the saying, “Cash is King”!.
There are enormous benefits of using the cash basis of accounting. It provides clarity by only showing what has been collected or spent, helps with cash flow management, and is more efficient when determining taxes.
Although a number of the clients in our network have “Done With You” (DWY) or membership business models, payment is processed before access to the course or offer begins. The other clients in the DFY space rely on monthly retainers for revenue or large installments for once-off projects where certain milestones are completed.
We often are so focused on increasing monthly recurring revenues (“MRR”) and concentrating on new client acquisition that we forget the ‘low hanging fruit’ right in front of us, collecting cash from our current client base. The opportunities can benefit our businesses with better cash flow and growth and result in greater efficiencies.
Measuring and tracking processes
One of the most significant challenges we see with our clients is the inability to measure and track whether we are improving our processes and systems of collecting outstanding receipts.
There is an easy way to see what is still outstanding through reports generated by accounting platforms (Debtor Ageing), but how does one accurately determine if we’re becoming more efficient in our collections? Remember, if you cannot measure it, you cannot manage it.
So we created a system to help business owners, with retainer-based revenues and invoices outstanding, with a tool to improve the process of collecting these outstanding receipts.
We use a metric called Days Sales Outstanding (“DSO”), which provides the average days our invoices are outstanding over a given period.
The formula used to calculate this is as follows:
The formula used to calculate (“DSO”)
Calculating Total Days Outstanding
(“Accounts Receivable”) / (Accounts Receivable + Monthly Cash Sales) * number of days in that month
If you have 30-day terms and your DSO is greater than 30 days, it displays a very unhealthy collection process. You continuously want to track this month on month to ensure that the DSO is as small as possible.
It is always a great sign if this is trending downwards over a specified period and is also one of the key metrics that potential investors or financiers will look at to understand the cash required to invest in the operations of the business (working capital).
Here is a quick example:
If you have $22,000 outstanding at the end of September and your total sales (cash collected and invoices outstanding is $45,000), your DSO is 14.67 days. If we only have $15,000 outstanding in October and our total sales are $50,000, our DSO improves to 9.3 days.
There you have it – a simple metric to track your collection efficiency.
You can do the same for expenses that you owe (Days Payable Outstanding (“DPO”)) where it is most favorable to lengthen the terms to ensure greater cash on hand at any given time without tarnishing supplier relationships.
If you have any questions about working capital and implementing better cash payment strategies, please drop them in the comments below. Remember, cash is always king and is the catalyst for growth!