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Building bridges: weaving the story behind DSO changes as critical as ever.

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Day Sales Outstanding (DSO) remains the most requested and most reviewed metric by upper management, whether flawed from a credit function perspective or not. The mere mention of DSO, however, seems to draw significantly less criticism from credit professionals than was the case five years ago. Fortunately, fewer CFOs, treasurers and other upper management officers view DSO as a sort of infallible and complete measurement of what's happening, notably in the credit departments collections prowess. That is significant progress, even though the desire from upper management to receive DSO figures on a regular basis as a sort of go-to-first metric will not be going away anytime soon.

"There are so many variables to DSO, but basically over time, you have to measure something," said Kathryn Marsh, CCE, CICP, director of credit Mitsui & Co. [USA] Inc. "Of course it has its downsides, but we have to measure it to a certain extent because we need to know when we are getting paid." DSO (receivables balances/sales x number of days in a period) is the most widely known metric throughout various departments and functions of a company. It's taught at the academic accounting class level and discussed at length when new credit professionals enter the business. It simply gets the most looks in part because of its popularity with CFOs as well as the notable ease with which it is calculated unlike the credit-popular collections efficiency index or even best possible DSO.

Although credit people may have become slightly less averse to DSO and upper management may be slightly less dependent on it, it remains a measure that does not paint a complete picture of the efficiency of a credit department. As the trend of pushing for more of a seat for credit--or maintaining one gained over time--at the proverbial big table of a business' brain trust continues, it becomes all the more important for credit managers to provide more context on DSO than allowing a flat, cold number to speak for itself.

"If you have peaks and valleys in sales and collections, it makes things challenging," said Dennis Walsh, CCE, CEW, director of credit and collections at BE Aerospace, while serving as a panelist during the Executive Exchange: Performance Metrics session at NACM's 120th Credit Congress & Expo. "We have to keep educating the boss. 'You're right, DSO is going up ... but let's look at this other stuff [other metrics] or the reasons why.'"

Perhaps the key reasons credit professionals cannot allow DSO to singularly speak for itself without explanation is that the number represents a snapshot in time. The potential for unfair distortions is high, especially in certain industries. Industries like agricultural products, seasonally fashionable clothing or recreational sporting vehicles are among the many examples where a certain quarter will have a decidedly larger amount of activity.

"If you take your average over a year on one particular day, it can look really high," Larry Lipschutz, CCE, CICP, director of credit and collections at French Gerleman Electric Co., told NACM. "It could have nothing to do with how your credit department is collecting. You can increase DSO simply by extending the terms with an existing customer. Payments can be 100% on time, and the DSO could still increase.

"It is important that senior management understand the distinction that just because DSO is going up doesn't mean the credit department isn't doing a good job. At the same time, if more capital is caught up in receivables for 48 days one month, 50 days in another and 52 the next; it could be an issue. You need to drill into it."

If You Build It ...

One of the more poignant exchanges during the Credit Congress session came when audience member Jamie O'Sullivan, director of global billing, A/R, credit and collections at LinkedIn, brought up the concept of "Building a DSO Bridge."

"It's quite a useful tool, DSO bridging," O'Sullivan suggested. "It's a chance to explain what it is that caused it [a significant change]." O'Sullivan said his team does this on a quarterly basis to quickly and effectively note the "key movers" behind issues that may have caused a change in payments (e.g., a customer's reserves status changed, one large account had a problem, "linearity," customers unilaterally demanded different terms with all customers, etc.).

Walsh said his company also uses DSO bridging each quarter to explain fluctuations and that, at this point, company auditors actually request it. "We do it side-by-side," he said. "In our case, a DSO bridge is simply an explanation. We've identified the highs and the deltas. 'This customer was paying current and had a big project that went sideways.' It's a narrative to explain the deltas from period-to-period."

How the information is calculated and, in turn, presented can also be helpful. Many credit departments present DSO as a rolling, three-month measure rather than on a particular date. Those in industries with less consistency in day-to-day or month-to-month sales volume find this a more accurate way of presenting the all-important metric.

Examples of rapid changes with larger customers and significantly slower payments started coming to a head more frequently in the past few years. Companies with leverage over their creditors demanding exceedingly relaxed terms is among the newest trends creditors are facing that can cause a number of problems, including a spike in DSO measurement. U.S.-based big box stores (e.g., Target, Home Depot and especially Walmart) are increasingly using bulk buying power to help them lean on suppliers for changes in terms, often on the backs of suppliers and small competitors. In June 2015, a Walmart mass correspondence to suppliers noted that it would require simplified payment terms to better align with its average total days of on-hand delivery as well as more flexibility on warehouse allowances and defective allowances, according to an official memorandum. In addition, Walmart started offering a supply chain financing program to its suppliers--the ones that the company was at the same time refusing to pay more quickly without significant discounting--with an option of borrowing money from Walmart, with interest, if their slower payment times were hurting the suppliers' cash position. Any that sought gap financing through other institutions, however, were warned in the memo that they would not be allowed to participate in the "Walmart Supplier Alliance" at all.

Lipschutz said major changes necessitate the coupling of another metric with DSO, or at least the kind of explanation that bridging can help provide. This is especially important for those working in the credit department of a publicly traded company, where contact with upper management positions in finance might be scarcer.

"From a private standpoint, we have a chance to talk to management--I talk to the president regularly, and the owner, when he has questions is not averse to picking up the phone," said Lipschutz, who switched from a publicly traded company to a private one in 2012. "But I'm not sure you can get away from it at a publicly traded company. They see it [DSO] as a good financial management statistic. But everyone needs to know there's more to the story. I don't know that you constantly have to do it, but, as a credit manager, you must be able to explain that and dig into why that number is fluctuating."

Information Overload

It's easy for people to say they're fans of numbers, "data nerds" and the like. But it is also easy to bring too many data points or too much explanation to the table. Those in upper management typically are extremely busy--they want useful information and want to be able to process it easily as well as quickly. The credit manager who can talk about DSO in a way that provides info with punch and without dozens of extra data points that upper management might not have the time or interest to digest can, and often do, gain a reputation as someone who is adding value. Put differently, you don't want to lose your audience by making their eyes glaze over.

There is also the argument that too much information can water down the impact of those things a credit manager wants to stand out because they are the most helpful in explaining where DSO is coming from, particularly if it's not tied to any credit department failings. There's also the argument that diving deeper and deeper into the wormhole of possible measurements or focusing intense scrutiny on even the smallest customers can become too time consuming. At a time when credit professionals are taking on increasing roles in the permeating "do-more-with-less" culture of the last decade, is there really time to get lost in the myriad of options?

"Keep your DSO bridge as limited as possible, to the movers and shakers," O'Sullivan suggested. "You don't want to get in the weeds." Walsh agrees with this approach, noting every month his credit department provides an update on a limited number of data points, ones that are informative without being too terribly complicated. "I don't want to give management some 200- to 400-page book every month," he noted. "They're not going to look at it. I give them one page that has all the stats and then graphs."

Looking on the Bright Side of DSO

Remember, there's no use in demonizing what is the most used metric in every other department of most businesses. There may be superior measurements from the perspective of the credit department, but efficient credit managers know DSO will continue to be held in high regard by CFOs and treasurers for years to come. Major change in this realm can be slow and is more likely to mean what was evident in the past as well as today: the CFO holding on to DSO as most important but with greater interest in some other categories or more than a surface-level explanation of changes.

"I would suggest DSO is not as evil as it sounds. It's actually an extremely useful measurement," Walsh argued. "It's significant to understand how old your asset is, even if it may have nothing to do with how efficiently you're collecting your receivables. But it can have all kinds of other implications. If you don't know how one of the biggest assets on your balance sheet is performing, you're doing yourself a disservice."

There is no one-size-fits-all solution when it comes to which other metric is best to pair with DSO. Different data points will resonate better (or worse) depending on the industry, dynamics of the business or even the preferences of the boss in question.

"Without the right metric, you just kind of feel your way through," Walsh said. "You don't catch the small changes without metrics. They tell us where we are and where we are going."

Brian Shappell, CBF, CICP, NACM managing editor, can be reached at brians@nacm.org.
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Author:Shappell, Brian
Publication:Business Credit
Article Type:Cover story
Date:Sep 1, 2016
Words:1806
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