3 Ways Customer Intelligence Strengthens Customer Relationships

In the current environment, your customers might just go dark or churn altogether as they deal with their own business-critical issues.

How can you stay ahead of that? With relevant and actionable data on what’s happening with your customers, you can nurture and strengthen relationships in order to avoid losing them.

1. Stay Current on Customers

Customers didn’t forget about their favorite businesses — they just wanted them to deliver in new ways. And as quickly as a Google search.

Businesses now have to quickly figure out how to best allocate resources to different customers. Key questions that the C-suite needs to have top of mind nowadays include:

  • Which customers have the most promising sales growth?
  • Who recently stopped buying?
  • Which customers pay late or are getting riskier?

Customer intelligence tracks these types of behavior changes, identifies overall patterns in customers’ buying habits, and empowers quick and relevant business decisions.

2. Prioritize Key Customers

Customer behavior data helps businesses better up-sell and serve customers with segmentation. By syncing this data into a customer relationship manager (CRM) such as HubSpot and Salesforce, sales leaders can prioritize their customers by grouping them into “Champions,” “Late Payers,” or those they’re at risk of losing.

For example, Marketing can work with Sales to determine upsell/cross-sell strategies to the most profitable customers. Furthermore, marketing teams can leverage these segments to build ideal customer profiles that sales teams can use to target new prospects. In this way marketers can ensure newly sold customers are the best possible fits and are most likely to be successful long-term customers. .

3. Anticipate Future Opportunities

After syncing customer intelligence data to a CRM, businesses can plan outreach based on their current customers’ patterns. Having a smarter CRM allows businesses to seamlessly sell to more customers within the context of their operations.

For example, a customer may stock up for an annual industry trade show every December. Knowing this big order may be on the way, a salesperson may want to get ahead of it and up-sell bulk purchasing discounts or cross-sell any related services that could support their goals. With segmentation businesses can customize messaging to customers and close more up-sell opportunities.

Get more Customer Intelligence in Seconds

While generating customer intelligence may have taken an entire data team in the past, it can now be produced in seconds, and kept up-to-date in real time. Tally Street’s ability to pull data directly from sales invoices gives B2B companies access to previously untapped insights that only enterprise companies could afford in the past. With Tally Street’s insights Sales teams can better retain current customers, spot patterns to reduce churn, and create personalized approaches to up-sell and cross-sell services to lead customers to success.

Learn more about how to boost marketing operations and campaigns  with Tally Street or sign up for a free trial today!

Get to Know Your Customers

Get a free segment report from Tally Street to know your best (and worst) customers.

Why SMBs Need Customer Intelligence In Their Toolboxes

One of your biggest clients just called you with a massive, urgent order. They are one of your best repeat customers, who always pay on time. You are very tempted to postpone another client’s job to tackle it. But which job do you postpone at the last minute?

Sales are up 200% from this same time last year—it’s GREAT news, but that data doesn’t help you figure out how to prioritize the existing billable jobs. It’s a lot of clients to sift through for a quick decision that will really impact your bottom line.

Two words: Customer Intelligence.

It's Not Your Standard Business Intel

Business Intelligence helps you understand your high-level key performance indicators (KPIs), like knowing your sales are up 200% this year compared to last year.

Customer Intelligence tells you exactly which customers drive your business forward. Knowing that can help you create actionable insights. Like postponing projects for a late payer to make room for a more reliable client, and hopefully preventing losses like the above scenario.

Only customer intelligence would show that the client who called contributes 30% to your revenues. Thus making his project much more important to your bottom line than ALL your other current projects combined.

Categorizing your customers based on their transactions and behaviors is an optimum way to implement Customer Intelligence. Although the highest spenders are valuable customers, those who pay on time are important to your cash flow. This analysis can help you break down your best clients, form an action plan to determine their needs, and create more value for them. And your business.

Read on for 4 other key ways you can use Customer Intelligence to keep and grow your customer base.

1. Avoid customer concentration risk

Don’t put all your eggs in one basket. Too many sales from the same few customers, or what we like to call, “Customer Concentration Risk,” means that losing just one single customer might cause a 10-25% drop in overall revenue. If you identify this issue ahead of time, you can diversify your business more upfront, instead of having to deal with downsizing later on.

2. Group Customers So You Can Focus

Boost your efficiency and results by grouping customers based on their past performance and momentum. Segmenting customers (to use the technical marketing term) surfaces new insights from the underlying data to inform better decisions. For example, grouping customers into segments such as “Champions” or “Give Attention” can direct sales and support resources allocation.

CustomerSegmentLTVPurchasesTTM SalesPrev TTM SalesAvg Days to Pay
Langosh and SonsChampion$1,638,417129$698,175$451,24933
Hintz Sauer IncChampion$1,067,922589$183,140$237,1321
Bailey GroupLate Payer$964,48477$196,467$332,32977
Lehner Hyatt CorpDon't Lose Them$84,9384--$84,93810
Herzog GroupGood$82,98227$24,206$28,82953
Schulist and BartonGood$77,76514$756$2,86746
Harber Bros LLCGive Attention$67,1675--$33,59955

3. Drive Repeat Business

A 5% increase in customer retention can boost profits 25% to 95%. The fastest way to drive revenue growth is through repeat businesses with your current customer base.

Help your sales team concentrate on customers who’ve bought before, and haven’t bought for a while, by syncing segment information as well as sales and payment histories into your CRM.

4. Get Paid Faster

Late payments hurt. In fact 57% of payments to SMB’s in 2020 were collected late. Completely writing off customer debt is really painful.

Customer Intelligence can analyze individual customer payment histories and use them to make predictions of which customers will probably pay on time. By better anticipating customer payment problems before they happen, small to mid sized businesses can make cash flow more predictable, improve sales-to-cash, and better manage customer credit risk.

Get Started with Customer Intelligence

Now you can easily get Customer Intelligence to your team with Tally Street.

The first Customer Intelligence tool of its kind, Tally Street uses purchase history and behavior data to build a personalized, 360-view of your customers.

Anticipate problems before they happen. Uncover the customer stories and insights trapped in your accounting software (QuickBooks, Sage Intacct and Xero) using reports auto-created in Tally Street and then pushing them to each team in their favorite format.

Get the ground truth on all your customer analytics so you can keep each team aligned and centered on the customer. Register today for a free trial of Tally Street and get to know your customers a little better each invoice cycle.

Get to Know Your Customers

Get a free segment report from Tally Street to know your best (and worst) customers.

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

Better Insights with Improved Segmentation

We released our first customer segmentation feature in August 2020. That version borrowed concepts from the RFM model used by marketers. We made some tweaks and we added a metric for how well customers pay, and it was good. The automatic grouping of customers into segments like Champions or Give Attention helps small businesses tailor sales and marketing to fit their best customers and the ones they risked losing. After working with our customer base, we learned a lot and realized there was room for improvement.

What We Learned

Although our segmentation helps businesses better categorize their customers, one of the biggest places for improvement was to increase the importance of momentum. For example, two customers who both bought 15 times and spent $60k over the same 3-year period fell into the same segment. That happened even if Customer A started small and is growing quickly while Customer B started big and trailed off — and a business owner or sales exec would definitely prefer more Customer A’s, and would consider Customer B a churn risk.

Another issue was a tendency to overvalue frequency. For example, a customer paying $120K upfront for a year of service scored lower than a customer who paid $10K per month over the same year, even if both had done that for multiple years. But most businesses would consider the annual commitment to be at least as good if not more valuable.

Our Improvements to RFTM+T

So we went back to our (virtual) whiteboard. We tried to create better customer grouping by applying more clustering using various machine learning models. But each SMB tends to have hundreds of customers, not millions of them, and they can be pretty different from each other. So the models had a hard time generalizing customers into useful clusters.

The best results came from applying more of the experience and knowledge that we’ve accumulated after working with hundreds of small and midsize businesses across all industries — and understanding how SMBs think about their customers and their growth. That led us to make the following improvements to recency, frequency, monetary and timeliness (RFM+T).

Recency: The last time the customer made a purchase is still the key input, but we also consider the typical customer retention period for each business. So if a business has an annual sales cycle, then customers who bought one month ago or 10 months ago are treated more similarly.

Frequency: Instead of looking at just the number of times customers made purchases, we now incorporate whether their purchase frequency is steady, increasing or decreasing.

Monetary: Customer lifetime value (LTV) is a great metric, but it can also overweigh the importance of sales made a long ago. So we now give more weight to the sales momentum of each customer.

Timeliness: The average number of days each customer takes to pay on invoices (aka Tally DSO) remains the key input. The new improvement adjusts for whether their average days to pay is less than or more than their typical payment terms.

A Better Picture of Your Customers

Each business has a unique customer mix and business model, and each one gets their own application of the segmentation mode, so the results will definitely vary! But a few changes are common across most SMBs.

First, it’s harder for customers to be in the Champion segment. Just being “big” no longer tips the scale as much. True Champions are still engaging and growing, and therefore have increasing momentum in LTV and buying frequency, while continuing to make timely payments.

But many businesses will see more customers in the Good and Promising segments. These are customers who are engaged and buying, but don’t show the same high growth rates as Champions. Now you’ll be able to identify these ideal customers and can spend time nurturing them to grow with you.

The ability to identify churn risks was boosted by increasing the importance of falling momentum and velocity. Now businesses will see more customers move into the Don’t Lose Them and Given Attention segments, giving them more opportunities to reach out before it’s too late!

Customer SegmentCustomersAvg LTV# of PurchasesTotal TTM SalesAvg Days to Pay
Champion22$163,450133$1,711,00517
Good71$65,99917$781,21619
Promising44$11,7723$56,9761
Don't Lose Them14$25,1488$44,98012
Give Attention16$16,2996$27,36220
Hibernating29$14,3254$012
Possible Mismatch45$1,6311$01
Late Payer18$102,22734$435,24986

Use Google Sheets and CRMS to Take Action

A great way to put customer segments to good use is to push them into other platforms. A good place to start is to connect Tally Street to Google Sheets. This creates a “live” version of the Tally Customer Sheet inside Google. Then you can build out your roll ups on other tabs and easily share the results with your team members.

An even better solution is to sync customer segments to CRMs. Making the connection between Tally Street and HubSpot or Salesforce only takes seconds, and your company and account records are enriched with not only their segment, but also their sales and payment histories. Sales, Marketing, Finance and RevOps teams can then add this new information to dashboards, build smarter lists and trigger new workflows.

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.

Smart Customer Segmentation for Growth

Acquiring new customers is important to success, but retaining customers is critical to profitability and long-term growth. An earlier article explained how to track retention by calculating and tracking customer and revenue retention metrics. That used to require lots of spreadsheet work, now connecting Tally Street to your cloud-based accounting software makes it easy and automatic.

Know how to drive growth through smarter customer acquisition and retention!? Part of the answer is to focus your new sales efforts on the right subset of customers who are most similar to your best current customers AND to retain your best current customers. The key to doing this is through customer segmentation.

Automatic Customer Segmentation Using RFM+T

Most small and midsize businesses (SMBs) don’t have the time, resources and tools to do their own customer segmentation. But SMBs do have accounting systems filled with customer sales data that can be processed to automatically segment your best from your worst customers (and everything in between).

We do this using RFM, a tried-and-tested model that sophisticated marketers have used for years. We made a few tweaks to the traditional model, then applied a combination of smart software and human intelligence to automatically group customers into categories that SMBs can quickly start using to make better decisions.

One of those tweaks was to add “T” to the original RFM model. Most business-to-business (B2B) companies make some or all of their sales on credit, eg, net-30 payment terms. Extending credit to customers greases the sales process, but customers who frequently pay late are a drag on cash flow. So we added a fourth component to include timely payments as part of the overall customer value.

  1. Recency: The last time the customer made a purchase. We use the date of the most recent invoice or sales receipt.
  2. Frequency: The number of times the customer made a purchase. We add up the total number of invoices and receipts for each customer.
  3. Monetary value: The amount of money the customer has spent. We use the customer’s known lifetime value (LTV), which is the sum of all their invoices and receipts.
  4. Timely payment: The time it takes customers to pay for their purchases. We use the Tally DSO, a very accurate measure of the average number of days each customer takes to make a payment.

After compiling the sales and payment data for each customer, our software individually evaluates and scores customers on R, F, M and T. We then use the individual scores and the aggregate scores to segment every customer into one of the following categories:

  • Champion: Your very best customers, they buy often, spend a lot, and pay well
  • Good: Solid customers who have been generating reliable sales and payments
  • Promising: Mostly newer customers who will hopefully move up to Good or Champion
  • Don’t Lose Them: Former Champions or Good customers who haven’t purchased recently
  • Give Attention: Previously Good or Promising customers who might be saved
  • Hibernating: Maybe asleep or could be lost (churned)
  • Possible Mismatch: Might not have been a good fit with your business
  • Late Payer: Your worst paying customers, including potential Champions and Good customers
  • New: Customers who made at least one purchase but haven’t made a payment yet.

B2B Customer Segmentation Examples

Once our software does the hard work of analyzing and tagging each customer, it’s easy to start comparing performance across segments. In the following example, the 33 customers tagged as Champions have the highest average lifetime value (LTV), purchased an average 126x each, and pay in an average of 18 days. It’s definitely worth digging into what the Champions have in common (eg, bought the same products, has the same sales rep) so you can find and make more of them!

Late Payers near the bottom of the table look a lot like Champions, except they take an average of 81 days to pay, 350% longer than Champions. An effort to improve collections from those 23 Late Payers looks like a quick way to create more champions and boost cash flow!

Customer SegmentCustomersAvg LTV# of PurchasesTotal TTM SalesAvg Days to Pay
Champion22$163,450133$1,711,00517
Good71$65,99917$781,21619
Promising44$11,7723$56,9761
Don't Lose Them14$25,1488$44,98012
Give Attention16$16,2996$27,36220
Hibernating29$14,3254$012
Possible Mismatch45$1,6311$01
Late Payer18$102,22734$435,24986
New1$3,9551$3,955--

To see who those Late Payers (and potential champions) are, you can switch to the customer-level details in the Tally Customer Sheet. In the table below, we quickly see that Bailey Group has the 3rd highest LTV, about 8x the average for Late Payers, but takes an expensive 77 days to pay. Speeding up collections from Bailey Group should be a top priority.

CustomerSegmentLTVPurchasesTTM SalesPrev TTM SalesAvg Days to Pay
Langosh and SonsChampion$1,638,417129$698,175$451,24933
Hintz Sauer IncChampion$1,067,922589$183,140$237,1321
Bailey GroupLate Payer$964,48477$196,467$332,32977
Lehner Hyatt CorpDon't Lose Them$84,9384--$84,93810
Herzog GroupGood$82,98227$24,206$28,82953
Schulist and BartonGood$77,76514$756$2,86746
Harber Bros LLCGive Attention$67,1675--$33,59955

Customers further down the ranks present great retention opportunities. Lehner Hyatt Corp, Feeney – Zemlak, and Harber Bros LLC appear to be Promising or Good customers — except they haven’t made any recent purchases. Identifying these high churn risk customers as early as possible gives sales and support teams the opportunity to save them and grow them into better customers.

Get your Own Customer Segmentation Results

Getting results for your own business customers is easy and free! You can connect Tally Street to QuickBooks, Xero or Sage Intacct and receive results based on your customer sales data in about five minutes. The only requirement is that you keep sales invoices and receipts in the accounting software you use. Start your free trial, you can cancel any time.

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.

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.