A Simple Guide to Calculate DSO Days Sales Outstanding for Construction Business
- Cost Construction Accounting
- May 23, 2023
- 5 min read
Updated: Sep 26
In the construction industry, efficient cash flow management is crucial for success. One of the most powerful metrics to help you achieve this is Days Sales Outstanding (DSO). Understanding how to calculate DSO days sales outstanding and effectively track it can be a game-changer for optimizing your company’s cash flow.
This article explores the top 10 questions about DSO in construction, offering practical insights to strengthen your accounts receivable process and sustain healthy cash flow. So, grab a cup of coffee and join us on this journey to financial efficiency.
Table of Content:
1. What Is DSO?
Days Sales Outstanding (DSO) is a key financial ratio that measures the average number of days it takes for your company to collect payment after completing construction projects on credit. The days sales outstanding formula calculates how quickly your accounts receivable balance converts into cash. A lower DSO indicates your company collects receivables faster, improving your business's cash flow and financial health. Conversely, a higher DSO means payments take longer, potentially causing cash flow challenges.
2. Why Is Tracking DSO Important for Construction Companies?
Paying attention to day sales outstanding ratio can bring a wealth of benefits to your construction business, such as:
Boost Your Company's Cash Flow:
Reducing DSO means faster cash inflow, giving you more working capital to cover expenses, invest in projects, and seize growth opportunities.
Optimize Your Credit Management:
Keep an eye on your DSO to uncover any weak spots in your credit policies and collection practices. Once you know where the issues lie, you can make impactful adjustments.
Early Warning System for Overdue Payments:
A rising DSO can signal overdue invoices or payment disputes. By recognizing these trends early, your accounts receivable team can proactively address issues to maintain steady cash flow.
3. How Does DSO Vary Across Industries and Why It Matters for Construction?
DSO varies by industry due to differences in credit terms, payment deadlines, and invoicing practices. In construction, projects often have complex payment milestones and longer payment terms, which can lead to fluctuations in the days sales outstanding ratio. Understanding your construction niche's average DSO and comparing it to your company's days sales outstanding helps you benchmark performance and manage your cash conversion cycle effectively.
4. How To Calculate Days Sales Outstanding?
The DSO formula is super simple to calculate:
This formula calculates the average number of days needed to collect payments. It does so after completing a construction project. Keep an eye on DSO trends to get valuable insights into your client's payment habits. With this knowledge, you'll be able to better predict cash flow and keep your construction business thriving!
5. What Is a Good DSO for Construction Companies?
A lower DSO often means better cash flow management. It also indicates a more efficient collection process. Generally, a 45 days DSO is seen as average in the construction industry. However, this can vary based on factors like company size, customer base, and industry sub sector. For example, commercial construction firms might have a different average DSO than residential ones.
Every construction company is unique. A "good" DSO for one may not be the same for another. To set a suitable target DSO, follow these steps:
Dive into your DSO history:
Explore your company's past DSO performance to spot trends and uncover improvement opportunities.
Know your construction niche:
Research your sub-sectors' average DSO to get a benchmark that's truly relevant to your business.
Assess your uniqueness:
Think about factors like your customer base, payment terms, and project complexity. These can influence your DSO.
Set a realistic target:
With all this knowledge, establish a target DSO that's achievable and in line with your company's ambitions. Aim for a sweet spot between better cash flow management and strong customer relationships.
6. How to Lower Your DSO and Improve Cash Flow?
Here are proven strategies to reduce your days sales outstanding and accelerate cash inflow:
Streamline invoicing and collections by automating payment reminders and monitoring payment status.
Offer early payment discounts to incentivize timely payments.
Set clear credit terms and communicate payment deadlines effectively.
Regularly assess customer creditworthiness and adjust credit limits accordingly.
Provide multiple payment options to accommodate customer preferences.
Foster collaboration between sales and finance teams to align payment expectations.
7. DSO vs. Collection Effectiveness Index (CEI): Understanding the Difference
While DSO is a valuable financial metric, it's essential to understand how it differs from another key metric: Collection Effectiveness Index (CEI).
Definition and purpose:
DSO calculates the average days needed to collect payment.
CEI measures how effective your collection efforts are.
Calculation:
DSO: (Accounts Receivable / Total Credit Sales) x Number of Days in the Period
CEI: (Beginning AR Balance+ Credit Sales During Period - Ending Total AR Balance) / (Beginning AR Balance+ Credit Sales During Period - Ending Current AR Balance) x 100
Interpretation:
DSO: A lower DSO indicates better cash flow management and a more efficient collection process.
CEI: A higher CEI (closer to 100%) shows your company collects a larger percentage of its receivables. This indicates more effective collection efforts.
Tracking both DSO and CEI helps you understand your contractor's performance. It provides insights into your company's credit management and collection efficiency.
8. How Technology Can Help Manage DSO in Construction?
Leveraging construction accounting software like Sage 100 Contractor can automate invoicing, send payment reminders, and provide real-time financial data. This automation reduces errors, improves payment status tracking, and supports your accounts receivable forecast, ultimately lowering your company's days sales outstanding.
9. Contracts and Payment Terms: What is the Impact on DSO?
Payment terms and contract agreements can significantly impact DSO in construction.
To minimize their effects, be sure to:
Clearly outline payment terms and conditions in contracts
Establish milestones and progress payments
Communicate proactively with clients to address payment-related issues
10. How CCA and Sage 100 Contractor Make DSO Management a Breeze
Construction Cost Accounting specializes in bookkeeping for construction businesses using Sage 100 Contractor. Our experts help you:
Automate invoicing and collections for timely payments.
Generate accurate financial reports, including DSO and other key financial ratios.
Provide tailored advice to improve your business’s cash flow and financial stability.
In Conclusion
Understanding and calculating your company's days sales outstanding is essential for maintaining a healthy cash flow and financial stability. By tracking DSO, optimizing your accounts receivables process, and leveraging technology and expert support, you can reduce overdue payments, improve your cash conversion cycle, and build a successful construction business.
Ready to take control of your cash flow? Don’t hesitate to reach out to CCA and start optimizing your DSO today!
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