Among CFO’s there’s often talk about how to increase the efficiency of working capital in the organization. Is it by reducing DSO (Days Sales Outstanding), reducing DIO (Days Inventory Outstanding) or extending DPO (Days Payment Outstanding). Sounds like an acronym cocktail right? Basically, do I collect my own sales receipt faster, get inventory/deliverables out of the door faster or just pay my suppliers later.
Conventionally, extending DPO ends up being the first route of increasing working cap, followed by chasing up on those receivables (DSO). It’s a lot easier to pay suppliers later than chase receivables and or think about your internal process (inventory operations)
In a large organization directly reducing DSO is impractical. From a pure financial perspective, those multi million dollar contracts are better dealt with via access to bank trade credit. But what if you can impact DSO in another way?
Before you think of extending payments out to another 30/60/90+ days for your suppliers (weakening your supply chain), have you thought about better impacting the process by which ‘inventory’ goes out the door, thereby indirectly improving your DSO?
Some industries will likely have operational nuances to DSO for example manufacturing dependent on a specific raw material before shipping. In a VendorMach data set of 1,500 anonymized UK private firms, there were significant differences by industry, the median DSO it took firms in manufacturing was 96 days to collect their receivables, 31.5 days longer than other professional, scientific and technical services firms.
In professional services firms, ‘inventory’ that lead to deliverables can be as simple as ‘decision making’ within your organization that leads to requirements before work product is shipped
Some process related points to consider are:
Are the requirements clearly defined to client and all stakeholders?
Do we have all HR requirements and checks and balances to meet the obligations?
Are there provisions for exceptions/delay in work product that may affect payment cycles?
Do you have in place quantifiable SLAs that govern the contract and payment cycles?
Have you defined what’s acceptable to you and client from a ‘quality’ perspective?
Do you have a process in place to quickly replace a strategic supplier in the event that the current arrangement fails?
Do you have a disaster recovery plan in place to quickly address any data breaches that may occur?
While it may seem a challenge to discuss these processes especially with multi year contracts, it’s never too late to begin that discussion. Even just a marginal reduction of DIO can net you millions of dollars in increased working capital while creating better efficiencies that will end up saving you even more of your earnings
Cover image: Source: VendorMach. Profit and Loss in UK GBP. Median DSO: in Days