Running a construction business is no small feat. From managing projects and teams to navigating supply chains and client relationships, there are always a lot of things to do. But there's one often-overlooked aspect that can make or break your business: DSO, or Days Sales Outstanding. In this article, we'll delve into the various ways in which a high DSO can impact your construction business. Moreover, we'll discuss how a high DSO can affect your creditworthiness. It also limits your growth opportunities and even puts your business at risk of bad debt.
Understanding Day Sales Outstanding (DSO)
Before diving in, let's break down DSO. It represents the average number of days it takes to collect payment after a sale (completed project in construction terms). It’s also referred to as the average collection period. To calculate DSO, divide the accounts receivables by the total credit sales and multiply the result by the number of days.
A high DSO translates to longer waiting times for your hard-earned money, hindering your ability to:
Fund new projects: Limited cash flow restricts your capacity to take on new ventures, hindering growth and profitability.
Pay employees and suppliers: Delayed payments can strain relationships with employees and suppliers. It will impact morale and jeopardize future partnerships.
Invest in equipment and resources: Restricted cash flow limits your ability to invest in essential equipment and resources necessary to maintain a competitive edge.
Why is DSO important?
Days Sales Outstanding (DSO) is important for several reasons, all of which boil down to the health of your business, particularly its cash flow. It serves as a crucial metric for assessing a company’s financial well-being.
By monitoring DSO, companies can effectively gauge their cash flow and working capital management.
Effective cash flow and working capital management are vital for sustaining performance and fostering growth.
Elevated DSO can result in cash flow challenges and detrimentally impact profitability.
The Domino Effect of High DSO on Your Business
1. Cash Flow Constraints:
High DSO means it takes longer for your receivables to convert into cash. This delay can lead to cash flow constraints, making it challenging to cover day-to-day operational expenses such as payroll, material costs, subcontractor payments, and equipment maintenance. Cash flow constraints may also limit your ability to invest in new projects or seize opportunities for business growth.
2. Increased Borrowing Costs:
When your business faces cash flow shortages due to high DSO, you may need to rely on external financing such as lines of credit or short-term loans to bridge the gap. This can result in increased borrowing costs, including interest payments and fees, which erode your profitability over time.
3. Strained Supplier Relationships:
Suppliers and subcontractors expect timely payments for the materials and services they provide to your construction projects. A high DSO can strain your relationships with these stakeholders if you're unable to pay them on time. This may lead to delays in obtaining materials, reduced availability of subcontractors, or even souring relationships that could impact future project collaborations.
4. Impact on Creditworthiness:
Consistently high DSO can negatively impact your construction business's creditworthiness. Lenders, suppliers, and other business partners may view a high DSO as a sign of financial instability or inefficiency in managing cash flow. This can make it more difficult to secure favorable terms for financing, obtain trade credit from suppliers, or win contracts with clients who conduct credit checks.
5. Increased Risk of Bad Debt:
Extending credit to clients without proper evaluation or monitoring of their creditworthiness increases the risk of bad debt. A high DSO may indicate inefficiencies in your credit management processes, leading to a higher likelihood of unpaid invoices and write-offs. Bad debt reduces your profitability and consumes resources that could be allocated to more productive endeavors.
Taking Action to Reduce DSO
Putting successful strategies for reducing DSO into action is like building a strong structure. You can build a safer and more wealthy future by doing the following:
Check Your DSO: Think of DSO as how long it takes customers to pay your invoices on average. A high DSO means there's room for improvement in collecting payments.
Sharpen Your Invoices: Make sure your invoices are clear, accurate, and sent out quickly after each project milestone. Highlight the payment terms and due dates to avoid confusion.
Embrace Automation: Use technology to handle routine tasks in your accounts receivable department. This frees up your team's time and reduces the chance of mistakes.
Set Creditworthiness Standards: Have clear criteria for who you take on as clients. This helps prevent bad debt and keeps your DSO from growing out of control.
With a healthy cash flow management, you can secure better payment terms and discounts, further improving your profitability. By prioritizing DSO reduction, you are not just solving a short-term problem; you are laying the foundation for a sustainable and thriving construction business for years to come.
CCA - Your Solution with These Problem
Don't let DSO drag down your construction business. At Construction Cost Accounting, we specialize in bookkeeping services tailored specifically for the construction industry. Our team of experts understands the unique challenges you face and can help you implement these DSO reduction strategies and more. We'll streamline your financial processes, improve cash flow, and free you up to focus on what you do best – building! Contact Construction Cost Accounting today for a free consultation and see how we can help your business thrive.
