Category: Smart Cash Flow Programme
A tried and tested, complete ‘smart’ cash flow system aimed at micro-medium sized businesses. The methodology used in the programme should significantly improve cash flow and reduce your dependence on banks, or other forms of credit. This smart cash flow programme improves the DSO and speeds up your cash receipts. It is straightforward to implement and uses technology to automate repetitive tasks, to be more efficient and to further improve effectiveness.
Special Extended Credit Terms
Before beginning to monitor WADSO, some customers should be classified as Special Extended Credit Terms [SECT]. This means that the specific Debtor has been offered an extended credit terms but this is only be permitted by the Manager that oversees collections. The Collections Manager should think about the business needs of the company before deciding to classify any Debtor a SECT. This is important because SECT Debtors will affect WADSO.
It is most important that the Collections Agent, that is supervised by the Collections Manager, understands that SECT status is ‘special’ and only granted in certain circumstances. In many instance, the Collections Manager will refuse to approve a Debtor for SECT status. To avoid disappointment, the Collections Agent should only seek SECT on specific customers and specific, ‘out of the ordinary’ situations.
If any customer is on the Debtor SECT list the 7-Day Rule and 14-Day Rule remain unchanged. Depending on whether the customer has a 45, 60 or 90 day SECT will determine when the 25-Day, 35-Day, 42-Day and 45-Day rules still apply but do not occur on their respective days. Instead they use this table:
| SECT Rule | 25-Day | 35-Day | 42-Day | 45-Day |
| 45 Days | 42nd Day | 52nd Day | 59th Day | 62nd Day |
| 60 Days | 58th Day | 68th Day | 75th Day | 78th Day |
| 90 Days | 88th Day | 98th Day | 105th Day | 108th Day |
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The Importance of Time
When it comes to credit control and working capital, time is critical. More often than not, days and weeks are allowed to pass without actions being taken to get results. As you’ll see in the other articles in this Smart Cash Flow Programme, there are very simple ways to use time more effectively and reduce your reliance on banks or other sources of working capital.
Reducing your reliance on external working capital will not necessarily remove it altogether, particularly as your business grows. In many cases, a continuously growing business will always have a demand for alternative working capital. Using the DSO and WADSO methods in this Smart Cash Flow Programme will help.
The purpose of this article is to demonstrate how a simple understanding of time can reduce the cost of your working capital, particularly when using Credebt Exchange®. When you issue and invoice/ETR it has a date on it, this is the Issue Date. When you upload this ETR to the Exchange, you must enter the Expected Date. This is the date that payment is most likely to occur. The number of days between the Issue Date and the Expected Date. The Expected Date, minus the Issue Date is the Day Sales Outstanding, or DSO, value. This DSO value is used to calculate the Discount that will be charged on the Face Value of the ETR.
Expected Date – Issue Date = Day Sales outstanding/DSO
For example, an ETR with a Face Value of € 10,000 with a Revolving ETR Sales Agreement, or RSA, of 1.000% per month and a DSO of 30-days, means that the Discount charge will be € 100.00. The same value ETR with a DSO of 60-days, means that the Discount charge will be € 200.00. This is double the cost of the previous ETR. Therefore, if your DSO is moved from 60-days to 30-days, you will reduce your finance costs by 50%. Time is, most definitely, money. Time is very important.
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Weighted Average DSO [WADSO]
As explained in the Day Sales Outstanding [DSO] article, there are only two technical terms we refer to in the programme DSO (pronounced D-S-O or D-SO) and WADSO (pronounced WAD-SO). Once you’ve read and understand how DSO is calculated, WADSO is the tool that measures performance i.e. how effective your cash collections are. WADSO is short for Weighted Average Day Sales Outstanding.
The previous article defined the sale and invoice components used to count the number of days in the DSO. With DSO clearly defined, WADSO can be calculated. Takes the sample list of invoices below as an example. The average days that these invoice is outstanding is 54 days, or a little under two months. If you called your credit control people and asked them what the average DSA was, a DSO of 54 doesn’t sound too bad. However, this is not an accurate measure of the real average days outstanding because it does not take into account that there is one big invoice for 1,000,000 that hasn’t been paid for three months!
| Invoice No. | Face Value | DSO | SumProduct | Weight % | WADSO |
| 00001 | 1,000 | 30 | 3,000 | 0.03% | 0.01 |
| 00002 | 10,000 | 45 | 450,000 | 0.49% | 0.22 |
| 00003 | 1,000,000 | 90 | 90,000,000 | 97.61% | 87.85 |
| 00004 | 25,000 | 60 | 1,500,000 | 1.63% | 0.98 |
| 00005 | 5,000 | 45 | 225,000 | 0.24% | 0.11 |
| Totals | 1,041,000 | 54 | 92,205,000 | 100.00% | 89.16 |
| WADSO | 89.16 |
The purpose of the weighted average is to give a more accurate representation of the average amount of money across the entire book of outstanding debt. To accurately measure this, each DSO is weighted in order to provide a more accurate payment analysis. Using each DSO weighting, the Weighted Average Day Sales Outstanding [WADSO] is actually 89 days. This is three months and almost double the DSO average figure.
Using the above table of date, SumProduct is calculated by multiplying the two known values: Face Value and DSO and WADSO is calculated by dividing the SumProduct by the total SumProduct to get a Weight for each payment received. The Weight is then divided by the DSO to get the weighted value for each payment. Only then can the WADSO be calculated
WADSO = Total SumProduct / Total Face Value
As you move through this Smart Cash Flow Programme, WADSO is used to measure the true performance of your cash collections/credit control personnel.
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Day Sales Outstanding [DSO]
There are only and two technical terms we refer to in the programme DSO (pronounced D-S-O or D-SO) and WADSO (pronounced WAD-SO). Don’t get distracted with all the other cash/credit control jargon like Collection Effectiveness Index, Transaction Turnover per Cash Applicator, etc. They’re too complicated and aren’t used in this programme. This programme is focused on real results that are measured on ‘cash in the bank’. Real results use are achieved using the combination of DSO and WADSO.
Before getting to DSO, let’s be very clear on what a sale is and also what constitutes an invoice. The issues that many business owners experience in collecting payment from their customers may have nothing to do with their product or its delivery, indeed in many cases poor management of the documentation and invoicing are the real culprits. People moan about paperwork, this is a smart cash flow programme, so be smart and get yours right.
A sale is when the correctly executed provision of a service, or the delivery of goods that are fit for purpose, is completed. In other words, the provision of the goods/services is indisputable (let’s call this Quality). Only when Quality has been delivered can an invoice be issued. Don’t waste your time, or confuse your ultimate target of achieving a low DSO figure, if you’re not delivering Quality.
Once you’re sure of the Quality, then move to the invoicing of that sale. It is crucial that the invoice contains all the correct data when being prepared (more on this later). If the invoice is wrong (because of incorrect data) then it will go back and forth between your office and your customer’s before it’s finally correct. Only then should the ‘DSO clock’ start.
Based on a clear understanding of the above, Day Sales Outstanding, or DSO, is the amount of days it takes from the date on the invoice, to actually receiving payment in full, that appears on your bank statement. Most DSO definitions forget to mention the payment must appear as cleared funds in your bank. That’s probably because they don’t consider the real world situation where payments can and do ‘bounce’.
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The Smart Cash Flow Programme
From 25 years of owning and operating small companies (and some large ones too), one of the hidden costs of doing business has always been our bank charges, fees and, of course: the lending/borrowing interest rate charges. These can be prohibitively expensive so we devised a simple smart cash flow programme to ensure we kept bank fees, charges, lending rates and ‘one-time’ management fees (let’s call all of these Hidden Bank Charges) to the absolute minimum.
As most micro-medium business owners will understand, trying to negotiate reduced bank fees and rates is largely a waste of time. Given the current banking situation, most business owners are too scared to even call their bank, let alone try to negotiate a reduction in any Hidden Bank Charges. Keeping this in mind we went about developing a smart cash flow methodology with a simple set of procedures to improve our cash position.
This blog covers all the smart cash flow ‘tricks’ we developed and over the next few weeks it will provide an entire programme that your credit control people (i.e. the people in your company that collect cash from the people and organisations that owe you money) can easily adopt. Most importantly, we don’t move the costs around from one area (the bank) and ‘jack up’ the workload on another (your people).
As its name suggests, this is a smart cash flow programme that uses technology to reduce the workload whilst improving cash collections and maintain the key objective of reducing Hidden Bank Charges and DSO. Before setting out the programme, let’s first understand some of the basic terminology used in credit control and also look at some of the language used on the dreaded bank statement where most of the Hidden Bank Charges can be found (not all bank charges are clearly identifiable from the bank statement… more on this later…).
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