Tuesday, January 27, 2009

Collections is Key to Good Cash Flow

Is your cash tied up in accounts receivable?  If you collected your receivables would you be able to make payroll and buy the inventory you need?  For financial help for small business there are some important considerations for cleaning up your old receivables and making sure you collect your receivables before they get old.

First, we need to understand how long it is taking you to collect.  The most commonly used ratio to determine this is Days Sales Outstanding (DSO).  The calculation is not difficult:

(Accounts Receivable Balance / Estimated Annual Sales) X 356 = DSO

This will tell you how many days, on average, it is taking you to collect.  Is your number too high or too low?  First, what terms do offer your customers.  If you offer net 30 terms and your DSO is 45 days, you may have some problems.  Second, what is your industry's average DSO?  Are you higher or lower?  These two factors will give you a benchmark for how you are currently doing.

There are many initiatives a company can implement to improve, or reduce, its DSO - which will result in better cash flow for the company.