Small Businesses Collect More Than Half of Their Money Late

Analysis Of Quickbooks And Xero Data Highlight The Problem And Opportunity For Accountants And RevOps

It’s no surprise that small business managers tend to focus on growing sales to build their businesses. But it is a surprise that many managers don’t pay more attention to collecting payments on the sales that they made.

We see this every week as we talk to SMBs about their sales and collections performance. Managers often say they don’t have collections problems. However, after they connect Tally Street to QuickBooks, Xero or Sage Intacct, our reports highlight the size of the problem. Once this is recognized, managers appreciate how addressing this collection delay can help fund their growth.

Late payments are another pandemic for small business-to-business companies. We analyzed over $3 billion small business sales in the US and found that 57% of payments in 2020 were collected late. And not just a little bit late, 17% of payments were collected more than 30 days after the due date. For a $10 million business that means $5.7 million was collected late and $1.7 million collected very late — which could have been used to accelerate investments or hiring.

More Than Covid Lockdowns

You might attribute the large share of late payments to the very different year that many businesses had in 2020, but you’d be wrong! The performance in 2019 was actually worse, with 62% of small business payments being collected late.

That may seem counterintuitive at first, but when times are good (2019) many businesses loosen their credit policies and collection efforts. Then they tighten up when the market turns for the worse (2020) and there are more reasons to suspect that customers may not be able to pay what they owe. Times were good in 2019 with gross sales up 27% over 2018. Then gross sales fell 8% in 2020.

Painful Hit To Cash Flow

Most SMBs are self-funded, making delays collecting accounts receivable especially painful to small businesses. That’s because SMBs really have just three ways to manage working capital: (1) accounts receivable, or money customers owe them, (2) accounts payable, or money they owe others, and (3) inventory.

The average company might have 40% of their working capital tied up in accounts receivable; in fact, professional service, software and other companies who are inventory-light might have 60% of their working capital tied up in A/R. This means that waiting an extra 30+ days to get paid can put a serious strain on the company’s ability to invest in other parts of their business.

What To Do About It

There are a number of steps that SMBs can take to improve collections performance.

  • Define credit policies and use them. That includes using consistent payment terms so that every customer knows when payments are expected. Good credit policies also include penalties for late payments, which need to be applied and can later be forgiven.
  • Remind and follow-up with customers. Emails and documents get lost, people go on vacation, etc., and sending friendly payment reminders before and after the due date are often all it takes to significantly improve collections. Making it easy for customers to pay also helps.
  • Measure performance and set goals. What gets measured gets done, and incentives help. A/R collections metrics such as DSO, ADD, DBT and the collections effectiveness index (CEI) track accounts receivable collection performance and are ideal ways to set goals and reward teams for hitting them.

Methodology

Tally Street analyzed over $3 billion in small business-to-business invoices across all industries and the payments on those invoices. The small businesses had annual revenues below $100 million. The dates payments were received were compared to the due dates from the invoices, and if the payment was late the number of days late was calculated for each payment. The total dollar amounts for each bucket of late payments were summed and expressed as a percent of the total payments received.

Learn How to Get and Use Customer Insights from Accounting Data

Accounting Systems are Treasure Troves of Customer Insights

Due to the rising importance of analytics and data science to boost customer intelligence and grow customer value, much derided accounting data are turning out to be some of the most valuable assets owned by small businesses. Large enterprises and SaaS companies led the way and built a sizable advantage. Now SMBs are catching up by combining cloud accounting systems with new tools that don’t require teams of data scientists. 

How Businesses are Valued Changed

Back in the 1890s the adoption of modern accounting practices led to business success being measured by financial ratios and statements. That remained the focus until around the 1970s when shareholder return became the more important indicator of success. Now customer value is the #1 metric and businesses that focus on customer loyalty are growing revenues 250% faster than their peers.

How Small to Midsize Businesses Can Generate Customer Value Insights 

The process of generating customer insights starts with customer data, which are crunched and transformed by data engineers and scientists. Then the results are shared across the company through internal reports and dashboards in the most suitable format for each department. 

SMBs don’t usually have  ready-to-go customer data in data warehouses or data lakes large enterprises do, but they do have accounting systems. Whether using QuickBooks, Xero or NetSuite, the accounting system is the ground truth for customer sales data. And since these systems store invoices and pay taxes, they’re also one of the most valuable data sources at SMBs’ fingertips. 

That makes accounting data a well-structured but untapped treasure trove of customer insights. Start with the simple, underappreciated sales invoice. Each invoice contains a wealth of information that can be aggregated across hundreds of customers and thousands of invoices to answer lots of questions! 

  • Date of the sale
  • Customer name and contact information
  • Line items for every product or service purchased, with quantities and prices and discounts
  • Payment terms

Customer lifetime value (LTV) is a good place to start and easy to compute by summing the invoices for each customer. That single number helps you rank customers and make other decisions, such as how much to spend on acquiring customers. For example, if the average customer has an LTV of $40,000, you might be comfortable spending $10,000 to acquire new ones. 

We know that not all customers are created equally. The average LTV might be $40k, but there will be small, one-time buyers and others who go on to spend much, much more. And how customers are growing or stalling matters. Smart software can analyze those invoices to separate your more promising customers from the mistakes. Grouping or segmenting your customers based on not just LTV but how often and how recently they buy helps identify upsell opportunities and anticipate churn.

That’s just the beginning. The same customer sales data in your accounting software can identify changes in a customer health score such as customer concentration risk, net revenue retention, and payment risk. Even more value comes from how these metrics trend over time and how they’re used to trigger new actions.

Final Thoughts

Finding the treasure hiding in your accounting data is easier than you think. Most SMBs have moved to cloud-based accounting software (eg, QuickBooks, Xero, Sage Intacct, NetSuite), especially after the switch to remote work in 2020. Now solutions such as Tally Street can reliably, safely and inexpensively generate new customer insights from the detailed sales data.

This presents accountants with a golden opportunity. As accounting data plays a larger role in a company’s success the role of accountants also changes. We see this happening in the emergence of the revenue operations (revops) function, which breaks down the silos between traditional accounting, sales and marketing operations to keep everyone better aligned. We also see accounting and bookkeeping firms providing more client advisory services and the AICPA offering a CAS Certificate. These changes are only going to accelerate, don’t miss your opportunity!

Customer Insights Now Pulled from Xero

Businesses using Xero can connect to Tally Street in just two clicks! With the Tally Street app now published in the Xero App Marketplace, it’s easier than ever for Xero users to dig actionable customer insights out of their Xero accounting data. Our customer and revenue retention trends will empower businesses to keep and grow their customer base with customer knowledge, easy integrations, and proactive reports.

Tally Street is a Xero Developer

Know Your Customers

Xero users can quickly discover the customer insights in their Xero accounting data and complete a 360 degree view of the customer lifecycle. The Tally Street app works with Xero by analyzing sales invoices and customer payments to automatically generate insights such as customer segments, lifetime value, churn risk, and payment risk reports..

Tally Street will allow Xero users to immediately know their most valuable customers and why. Over 30 performance metrics for each customer identify churn risks, payment risks, and more. Summaries of which products each customer buys over time drive better forecasting, upsells and cross sells. 

Customer and revenue retention

Easy Integration And Proactive Reports

Save time and keep everyone on the same page with a single source of truth distributed to accounting, sales, marketing, and support in the best format for each team. Results are proactively sent to you by email, synced to HubSpot or synced to Salesforce, connected to a “live” Google Sheet, and downloaded as PDFs and spreadsheets from your dashboard.

Connecting Tally Street to Xero takes just seconds, is read-only, and has no impact on the way you already use Xero. 

Tally Street in Salesforce dashboard

About Xero

Xero is world-leading online accounting software built for small business.

  • Get a real-time view of your cashflow. Log in anytime, anywhere on your Mac, PC, tablet of phone to get a real-time view of your cash flow. It’s small business accounting software that’s simple, smart and occasionally magical.
  • Run your business on the go. Use our mobile app to reconcile, send invoices, or create expense claims – from anywhere.
  • Get paid faster with online invoicing. Send online invoices to your customers – and get updated when they’re opened.
  • Reconcile in seconds. Xero imports and categorizes your latest bank transactions. Just click ok to reconcile.

Find out more or try Xero Accounting Software for free.

Manage Customer Risk Now and After Covid-19

Covid-19 Lockdown Impact On Small Businesses

Incoming cash falls 50% at small business-to-business companies.

Most of the small business alarms during the coronavirus lockdowns have been ringing for consumer businesses, with good reason since restaurants and retailers across the country are shuttered. Now we’re beginning to see the ramifications in the business-to-business vendors that support them and others.

Last week, small business-to-business companies saw sales fall to 73% of the average over the previous six months, and suffered cash collections falling to a life-threatening 50% of the average over the same period.

This drop in collections of accounts receivable is the result of lower sales combined with companies trying to conserve cash by delaying payments to their vendors. Days Beyond Terms (DBT) is a popular metric used by accountants to track how overdue late invoices are, and DBT hit 94 days in March, which is 24% higher than the average over the prior six months.

Covid-19 Lockdown Impact on Small Businesses

The 27% drop in sales and 50% drop in collections is after just 15 days of lockdown in March. Small B2B companies tend to have more cash reserves than restaurants, but most have fewer than 60 days worth. If both sales and collections continue falling in April, many of those small B2B companies will start running out of cash. 

B2B companies tend to process more invoices and accounts receivable collections during the last week of the month than in other weeks. Tally Street compared the last week, starting with March 29th, to the last weeks of the prior six months across the US and Canada. The results for last week may improve as backdated entries are made, but cash collections started trending down at the start of March and are expected to continue falling.

Triaging Small Business Customers 

Now is obviously the time for small businesses to conserve cash, but it’s also time to evaluate which customers to aggressively support and where to minimize risks.

Accountants and CFOs can help by preparing a master customer sheet. These spreadsheets list each account, how long they’ve been a customer, recent sales trends, lifetime value, credit limits, past payment performance, and more. 

Business managers and sales teams can use a combination of their customer sheet and their specific market and customer knowledge to flag each account as high, medium or low risk. High risk customers include those who might not survive: businesses should tighten collections and credit limits for them. Low risk customers present great opportunities: businesses might ease payments or extend more credit to build long-term loyalty and success.

Tally Street Customer Review Example

AICPA Selects Tally Street

2020 Lineup Announced for Startup Accelerator Tied to Accounting Innovation

Four Early-Stage Companies to Receive Guidance from the Association of International Certified Professional Accountants and CPA.com

NEW YORK (Feb 24, 2020) – Four early-stage companies pursuing various solutions involving digital assets, climate risk, automation and artificial intelligence will form the 2020 cohort for an accounting-focused startup accelerator sponsored by the Association of International Certified Professional Accountants (the Association) and CPA.com.

The startup accelerator, begun in 2017, is designed to promote innovation in the accounting profession and give the Association and CPA.com more visibility into disruptive trends from emerging technologies. Finalists get a nominal funding investment and guidance from a panel of experts in the profession on marketplace needs.  

“Many of these early-stage companies are offering a glimpse into how the profession will evolve,” said Erik Asgeirsson, president and CEO of CPA.com. “We have a common interest in nurturing that growth and ensuring that accountants have the best access to technological innovation.”

The members of this year’s group are:

  • The Climate Service – The North Carolina startup is developing a cloud-based solution  to help companies measure, manage and disclose climate-related financial risks
  • Gilded – The New Orleans company offers seamless invoicing, payments, and accounting for global businesses-powered by blockchain
  • Scanye – The Polish firm uses intelligent algorithms to automate document processing, accounting and finance management for small to medium-sized enterprises
  • Tally Street – The Boston-based startup created a “virtual analyst” to help businesses boost cash flow by using accounting data to find opportunities and anticipate problems before they happen

Each accelerator company will be able to present information about their business in June at ENGAGE 2020, a leading event for the accounting profession sponsored by the American Institute of CPAs (AICPA) and the Chartered Institute of Management Accountants (CIMA).

“We’ve heard from our previous accelerator companies what a great opportunity it has been to work with some of the leading thought leaders and influencers in the profession,” said Lawson Carmichael, chief operating office of the Association. “And the companies have offered us great insight in return.”

For more information about the startup accelerator, please visit aicpa-cima.com/accelerator.

About CPA.com

CPA.com brings innovative solutions to the accounting profession, either in partnership with leading providers or directly through its own development. The company has established itself as a thought leader on emerging technologies and as the trusted business advisor to practitioners in the United States, with a growing global focus. Our company’s core mission is to drive the transformation of practice areas, advance the technology ecosystem for the profession, and lead technology research and innovation efforts for practitioners. 

A subsidiary of the American Institute of CPAs, the company is also part of the Association of International Certified Professional Accountants, the world’s most influential organization representing the profession. For more information, visit CPA.com.

About the Association of International Certified Professional Accountants

The Association of International Certified Professional Accountants (the Association) is the most influential body of professional accountants, combining the strengths of the American Institute of CPAs (AICPA) and The Chartered Institute of Management Accountants (CIMA) to power opportunity, trust and prosperity for people, businesses and economies worldwide. It represents 657,000 members and students across 179 countries and territories in public and management accounting and advocates for the public interest and business sustainability on current and emerging issues. With broad reach, rigor and resources, the Association advances the reputation, employability and quality of CPAs, CGMAs and accounting and finance professionals globally.

Net Revenue Retention Drives B2B Success

How do $10+ billion companies like Docusign continue growing sales 30% every year? A big reason is Docusign’s high-level of repeat business. Not just repeat business, but repeat customers that keep increasing the amount they spend with Docusign.

Acquiring new customers is important to growth, but retaining customers is critical to the survival of businesses that depend on repeat sales to the same customers.

There are multiple ways to measure repeat business success, but key ones are customer retention and net revenue retention. Together they help B2B companies understand how they’re growing, improve customer acquisition and optimize customer lifetime value.

Customer Retention

Customer retention is simply how many customers did you retain from one period to the next. If you had 500 customers two years ago and 400 of them bought from you again last year, then you retained those 400, or 80% of your customers from the prior year.

The 100 customers who didn’t buy again were lost, or churned. That gives you a customer (or logo) churn rate of 20%.

But tracking the number of customers retained or churned is only part of the story. Some of the 400 customers that were retained may have lowered their spending. Or maybe they increased spending enough to offset the 100 customers that churned.

Customer Churn and Net Revenue Retention example

Get your free Value Impact Scorecard from Tally Street and receive a 3-year history of the customer and net revenue retention rates for your business.

Net Revenue Retention

Net revenue retention (NRR) provides a revenue-based view of customer retention. Over the last 10 years, NRR became a key, high-level metric that many software-as-a-service (SaaS) companies already track, but it also works for any product or service company that relies on repeat business for its success.

NRR uses the net of revenue expansion and contraction to help businesses measure the overall success of their customer retention efforts. So while losing customers will happen, you should be growing revenues from retained customers to compensate for you what you’ve lost — and that’s exactly what NRR captures.

The two components of NRR are revenue contraction and expansion. For example, if one of your churned customers used to buy $1000 of goods or services from you, then losing them results in $1000 of revenue contraction. Or if you retained a customer, but their spending fell from $4000 to $3000, then you had another $1000 in revenue contraction.

Revenue expansion comes from price increases, cross-sells, up-sells, and sales growth across existing customers. For example, if a customer spent $4000 with you last year and spent $5000 this year, then the customer contributed $1000 in expansion revenue.

NRR = (Prior period revenue + revenue expansion – revenue contraction) / prior period revenue

This makes NRR the most comprehensive retention metric because it actually tells the complete revenue story of existing customers — it answers the question of what your top-line revenue would do if you did not gain one more customer.

Powerful Boost to Revenue Growth

NRR becomes increasingly important as a small business grows to a midsized business (and beyond). For example, a $5 million business that churns 20% can replace that $1MM with new business when it’s growing 50%+ each year. But when it’s a $30MM business then it needs to replace $6MM, at the same time growth rates may be slowing.

NRR is also powerful because the effects are cumulative. It’s either a dividend or a tax that you pay on every group of customers that you acquire, and the more customers you acquire over time, the more this adds up.

This means that small differences in NRR add up to very large differences in total revenue over multiple years. In the following example, we assume a business had $10 million in revenue last year and consistently generates 20% of revenue from new customers. Improving the business’s NRR from 95% to 105% may not sound like much, but over five years the business has an extra $10 million in annual revenue!

Net Revenue Retention's Impact on Revenue Growth

See how NRR can improve your own revenue growth using this Google Sheet.

Improve Your Retention Rates

Your target number will vary significantly based on your business and industry. Many businesses can have a low NRR below 50% and still be successful. For example, a construction company probably doesn’t expect the same customer to order a new parking garage every year! On the other hand, software services (like QuickBooks) want to keep you each month and upgrade your service over time. For similar software companies, NRR should exceed 100% if they’re successful. 

Whatever your target NRR might be, every CEO should track it. And if you want to increase your NRR, here are some steps you might take:

  • Compare customers you retained and grew to ones you lost and look for patterns in the when/how they were acquired, the products they bought, their interactions with customer support, etc.
  • Consider what makes your current products and services “sticky”. Or look for opportunities to expand your product portfolio to grow a recurring line of business.
  • Review pricing levels and strategies, find opportunities to increase volumes and/or cross-sell other products.
  • Think about how you can shift spending between acquiring new customers and servicing existing customers.
  • Gain a single view of each of your customers, with acquisition details, lifetime value, purchase and payment histories, etc. 

In summary, customer and revenue retention rates are not just financial metrics. The metrics and the customer data required to compute and track them drive important business decisions and strategy everywhere from sales to product to customer service.

Is Your A/R Giving You Any Credit?

From time to time, small businesses need to borrow funds to cover cash shortfalls, manage seasonality, or take advantage of unexpected sales opportunities. Traditional banks tend to limit loan amounts to a percentage of the business’s net worth or a percentage of high-quality assets. For many businesses, accounts receivable is one of their most significant assets — and helping your lender appreciate the quality of that A/R can help you borrow the maximum amount at optimal rates. 

Bank Guidelines for SMB Loans

The maximum loan amount for many lenders is limited by one of two major factors: (1) net worth of the business and (2) asset, or collateral value. The net worth of your business is derived by taking the market value of your assets less the outstanding liabilities. Many banks will lend only 10-20% of your business’s net worth. 

But many banks will lend as much as 80% of the value of your major business assets — and accounts receivable can approach a third to half of all assets for the average small business. Lenders will typically ignore A/R they consider low quality or more than 90 days overdue. You should ask your lender about its specific policies and be ready to defend the quality of your outstanding A/R to get the best possible loan. 

Loan Packages Tell Your Story

First of all, most lenders want to make loans. Their compensation, job security, and career prospects are tied to the growth of their loan portfolio. But they still need to make good loans, and what constitutes a good loan is defined by the bank’s credit policy. However, the reality is that very few businesses comply with every factor considered in the bank’s credit policy. 

So when traditional banks consider loans for small businesses, they develop a loan package presentation that tells the story of the business, its customers and its ability to perform and repay the loan. This usually includes a current balance sheet, profit and loss statement, and up to three years of full tax returns. If the loan is secured by a business asset like accounts receivable, then other details will be needed, such as an A/R aging schedule.

The purpose of the final loan package presentation is to gain approval from a loan committee or manager. Even when your loan is approved you should also prepare to continually support your story by providing updated statements and reports.

Leveraging Accounts Receivable for a Better Loan

SMBs can often tell a better story and borrow more by leveraging their assets instead of relying only on the business’s net worth. Accounts receivable is often one of the most significant assets a small business has, but it’s also the one lenders need the most help evaluating. The critical things banks want to see include:

  • Customer stability, eg, how long they’ve been buying from you
  • Past purchase amounts, eg, annual sales history, recent sales 
  • Collections performance over 12 months or more, ideally with no unresolved issues

This is where an A/R aging schedule falls short. The aging schedule only lists the names and amounts due for customers that currently have outstanding invoices. It does not highlight the number of loyal customers you have or the quality of their payment history. 

Better sales analytics and customer reports can help. Tally Street provides summaries of overall sales and collections performance, including KPIs such as repeat sales rates, DSO and ADD.  Tally Street also generates customer retention, lifetime value, annual sales, and payment performance for each customer. 

These reports help draw a picture of your client base as buying from you regularly, paying you under terms offered consistently, and having a history of an established relationship. If you can show these details, your lender can tell your story, possibly gaining approval of an exception when considering more than just your A/R aging schedule. This information may make the difference in getting the loan approval or not.

First Steps to Client Advisory Success

If you’re reading this then you’re probably an accountant or bookkeeper who’s also been reading blogs, listening to podcasts, and attending conferences about the AI and tech-driven changes rolling through the accounting profession.

You already decided (correctly) that you need to transform into a firm of the future, adopt new technologies instead of resisting them, and outsource routine work to machines while focusing on higher-value advisory opportunities. You won’t be making this transition alone and there are wonderful people and resources to help you along the way. 

Still, it won’t be easy. Very much like a tech start-up you should outline your hypotheses about what your clients need, why you’re best positioned to help, and where you can apply your knowledge, skills and passion to make a difference. 

Getting started

Fortunately, you have a head start: an existing practice! This comes with advantages and assets you can leverage to build your advisory business. The first and most important one is your existing client relationships. Developing your hypothesis and then validating them with some clients will get you through the critical customer discovery and validation phases. (We’re big fans of Steve Blank’s The Four Steps to the Epiphany, which is mostly used by tech startups but could be used by just about everyone.)

Leverage your assets

Next take full advantage of your fluency with your clients’ accounting data. Realize how valuable and unique the knowledge and skills you’ve accrued really are. Some insanely talented business people don’t know the difference between basic accounting terms. Even more don’t appreciate the insights and learnings hidden inside their books. You do! You can tease them out, and then combine them with your intimate knowledge of your clients’ business to create stories when providing your clients advice.

Taking the first strategic steps

Finally, there are many stories buried in dry-looking accounting data but which ones are you most passionate about telling? If you get most excited about building high quality sales streams, then you can use sales order histories to give clients new insights into their customers. For example, you could explore how new and repeat customers differ, what drives different lifetime values (LTV) across the customer base, and how much retaining customers contributes to a successful business. To back this up, a popular and well known Bain and HBS study from 30 years ago found that increasing customer retention rates by 5% increases profits by 25% to 95%.

Other areas where almost all small business-to-business companies need help is understanding customer concentration risks, tracking changes in product sales mix, managing payment risks, and collecting on accounts receivables in effective and customer-friendly ways.

We can help

Our goal at Tally Street is to boost the advisory and controller services accounting and bookkeeping firms provide small businesses by surfacing the insights and learnings buried within sales data. By adopting technology like ours, advisors acquire an immediate, operationalized set of analyses to use across all B2B clients. We also provide these insights and results under your branding so you can share them directly with clients. 

Please contact us to learn more.

Aging Reports Growing Old?

TL;DR Summary

  • Accounts Receivable aging reports highlight outstanding invoices but they are poor tools for understanding actual collections performance and opportunities.
  • Days Sales Outstanding (DSO), Average Days Delinquent (ADD) and Days Beyond Terms (DBT) are good metrics for tracking overdue payments and invoices.
  • Business advisors of all types can use the combination of DSO, ADD and DBT to provide clients a more complete understanding of collections performance and boost cashflow while lowering risks.

Too many advisors and small businesses still use aging reports to measure how well businesses are collecting payments. AR aging reports are simply a list of outstanding invoices grouped into buckets of 30 days, which might not even be appropriate for a particular business or industry. We can all do better.

We reviewed Days Sales Outstanding in a previous article as a metric frequently used to track how quickly payments are collected, and we introduced Tally DSO as an improvement on the older methods. But DSO doesn’t differentiate between payments that are on-time or late, which can obscure other problems. So let’s dig into two other key metrics: Average Days Delinquent and Days Beyond Terms.

Average Days Delinquent

Average Days Delinquent (ADD) is similar to DSO but only for late payments. ADD is so similar to DSO that some call it Delinquent DSO. In other words, ADD is the average number of days late payments were late. 

The traditional way to calculate ADD is to first calculate the traditional DSO. Next, calculate the Best DSO, which is the ratio of current receivables to average sales per day. Then subtract the Best DSO from DSO to leave you with the Delinquent DSO (aka ADD). Got it!?

ADD = (Accounts receivable / Avg Sales per Day) - (Current Accounts Receivable / Avg Sales per Day)

This approach makes logical sense and might be good enough if you only have financial statements to use as a starting point. But it suffers from at least two shortcomings. First, it relies on “average sales per day,” which can change even if your collections period doesn’t change. Second, unpaid invoices get included and distort the results. 

A better approach is to work from the bottom up and make the calculation using actual (and only) late payments. To do that we calculate the number of days between the late payment date and the invoice due date. Then we compute a weighted average number of days across all invoices with late payments during the period.

Real ADD = Sum(Late Payment x (Amt Payment Date - Invoice Due Date)) / Invoice Amts with Late Payments

The result is the actual, average number of days late that payments were received. Tracking this ADD along with DSO tells a more complete story, as we’ll see in the example below.

Days Beyond Terms

Getting paid late hurts cash flow, but not getting paid at all is really damaging! The key metric to understanding how late customers are at any given moment is Days Beyond Terms (DBT). Simply put, DBT is the dollar-weighted-average of the number of days that overdue invoices are past terms.

Tally Street calculates DBT by filtering on invoices that were overdue at the end of the reporting period, then summing the number of days between the reporting date and the due date, and then dividing by the total amount outstanding as of the same reporting date. 

DBT = Sum for Invoices Overdue of ((Reporting Date - Due Date) x Balance) / Sum (Balances Outstanding)

Note that because DBT uses dollar-weighted-averaging, the ratio between the AR overdue and the total amount outstanding will skew the result. For example, if $100 is overdue by 10 days ($100 x 10 = $1000) and there is $200 outstanding, then the DBT is 5. But if there is $500 outstanding (still just the $100 overdue) then DBT is 2. So don’t think of DBT as the actual number of days money is overdue, but a measure of overdue pain!

Pulling It Together for Clients

DSO, ADD and DBT are valuable metrics, but no single one of them tells the full story. They must be evaluated together, along with knowledge of the underlying business, to discover opportunities for improving collections and boosting cash flow. This is when small businesses look to accounting, bookkeeping, and financial advisors for help!

For example, if DSO, ADD and DBT are all trending down then collection times are improving. But if DSO and ADD are trending down then late payments are probably increasing. If you see DSO and ADD moving in different directions then you probably need to dig into the details. For example, if DSO is rising while ADD is falling, the change in DSO might be the result of shorter credit terms and not an improvement in collections.

In the above example, DSO and ADD have been trending in the same direction and DBT remained fairly flat. The increase in DSO and ADD in March, while DBT slight decreased, suggests that some large overdue invoices were collected as overdue balances became late payments. Then after two months of improvements all three metrics start increasing, suggesting a notable degradation in performance, something your client needs to know!

Lastly, keep an eye out for the impact of disputed invoices. If customers delay payments while disputing invoices then DBT will increase as the overdue AR balance grows. If the dispute gets resolved and customers make payments, then there will be a bump in both DSO and ADD. If it’s more than a temporary problem and a growing number of invoices are being disputed, there could be serious problems with the sales process, the product or product delivery.

Our Alternative to the Misleading DSO Metric

TD;DR Summary

  • Days Sales Outstanding (DSO) is not weighted average days to pay, but a poor and misunderstood measure of how long it takes to collect payments on invoices, ie, generate cash.
  • True DSO is an improvement on the old method, but still has flaws, especially when there are multiple payments on an invoice.
  • Tally DSO is an improvement on True DSO that handles partial payments, adjusts for different payment and sale amounts, and can be compared to performance benchmarks of performance.

Cash Is Oxygen

Cash is oxygen for any business, and especially for small businesses who usually find it harder to issue debt or secure loans. Making sales and issuing invoices does not immediately generate cash, payments on those invoices still need to be collected. To say it in accounting-speak, sales orders need to be converted to cash.

Advisors and accountants can boost small business performance by helping them track and improve the efficiency of their collections processes. One of the metrics accountants have relied on for over 100 years is Days Sales Outstanding — unfortunately it’s also very misunderstood and can be very misleading. It’s outdated too, now that we can quickly analyze all transactions via solutions like QuickBooks and Xero.

DSO Is (Probably) Not What You Think It Is

Just the words “days sales outstanding” seem to suggest that it will tell you the number of days that sales are outstanding. So a DSO of 30 could be expected to say that it takes an average of 30 days to collect payments. But no! What a DSO of 30 really means is that the amount of money in accounts receivable equals 30 days of average daily sales. Maybe that’s interesting, but it’s not a way to measure collections performance.

DSO ratio = accounts receivable / average sales per day

A big problem with the DSO calculation is it relies on that “average sales per day” number. Say payments are always received in exactly 30 days, guaranteed. Then you’d expect a constant, never changing DSO of 30. But if there’s a quick increase in sales, then average daily sales goes up and DSO falls even though collections stayed rock solid at 30 days. (Dive into one or two detailed examples.) You would be misled into thinking cash was being collected more quickly when it’s actually not! And that could lead to some uncomfortable mistakes forecasting cash flow.

Also, the different ways in which companies compute average daily sales means that you can’t compare DSO results to other companies. That doesn’t help collections benchmark their performance.

True DSO Is A Partial Fix

A few, but not many, advisors also compute the “true DSO.” This requires calculating the number of days between each invoice date and final payment date, and then calculating the average. Or better still, calculating the weighted average. And it works — if you have only one payment on each invoice!

True DSO = Σ(Paid Date - Sales Date) / Sale Count  

OR

True DSO = ∑(Amount of Each Invoice * (Payment date - Issue Date)) / ∑(Invoice Amounts)

Introducing Tally DSO

We took True DSO a step further and developed an algorithm that works across any period and across any number of customers, and that handles partial payments. We first look at every individual payment, including those partial payments, and calculate the number of days between the payment date and the invoice date. Then we compute a weighted average days to pay across all invoices with payments during the period. We think the result is a more accurate measure of how many actual days it took to collect payments, and we call it the Tally DSO.

Tally DSO = Σ(Payment Amt * (Pay Date - Invoice Date)) / Σ(Invoice Amts with Payments)

Let us know if you have made other DSO tweaks of your own. We’ll also dig into other ways to measure collections performance in future posts, including the relatively new Collection Effectiveness Index.