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days sales outstanding

4 Ways to Advance Your Billing Process

Gary Dwyer
GaryDwyer
Product Director
BST Global
One of the most critical processes for any successful business is billing. To advance your own AEC firm’s billing processes, it’s important to understand four key ways that can help. The Billing Process Getting your billing to run efficiently, is an important step in optimizing your firm’s cash collection. But if you have a poor billing process that takes too long to get invoices out the door, that makes it difficult to collect the cash you need, when you need it. While it’s very possible for you to fix your firm’s billing issues, you can’t think of it as a one-and-done process. It takes time, and some trial and error, before you can get it right. By setting the expectation that billing cannot be fixed overnight and that it requires constant effort from all persons involved, you’ll make the chances of fundamentally improving this process much higher. How to Improve Your Billing Process There are four key elements you must pay attention to when working on your firm’s billing process. Let’s investigate each. Know the terms of the project: The more clearly defined your invoicing terms are in the contract with your client, the less likely you’ll be to have misunderstandings. And by “invoicing terms,” I not only mean how long your client has to pay the invoice, but also the layout and the content of the invoice. What goes into an invoice and what it looks like may be different for each project. But, by introducing standards to limit the number of varying invoice formats, it makes it easier to ensure your team is using the correct format from project to project. Schedule frequent billing reviews: Project billing reviews should be scheduled throughout every month. Because too many AEC firms still consider it a monthly event, this causes bottlenecks when trying to do a billing review of all projects in a compressed timeframe. Instead of doing it all at once, try spreading it across the month and doing a few projects each week.For example, say you have 100 projects going on at once, you can review 25 a week instead of 100 at the end of the month. And even if you’re not billing your client each month, it’s still a good idea to review the charges you’ve billed on a regular basis to make sure they’re allocated to the right project and the right task. Monitor the billing process: Project Managers, Project Directors, and Project Accountants are usually involved in the review process of the draft invoice or prebill. Because several individuals need to be involved, this can make it easy to lose sight of when each person is working on the bill.Ask yourself this: your Project Manager is done with their review – do you know if the bill moved to the Project Director, or is it back with the Billing department? If you don’t have the answer, then you should consider finding an ERP solution that allows your team to have a clear view of this process. Being able to see what stage the billing process is at helps alleviate confusion and eliminate the extra time it takes to track down prebills. Store documents electronically: Project billing typically requires copies of reports and receipts as backup for charges on an invoice. The problem is, many AEC firms still use paper-based backup systems. This involves a manual effort to find backup documents in filing cabinets, making photocopies of those documents, and then combining the copies.Instead, all documents should be stored electronically in a document management system. That way you can find them faster and you can combine them into a single PDF to send to a client with the final bill. The Impact Now you know the four ways you can improve your billing process – but what does all of this really mean for your firm? Well, it means you can expect a positive impact in two key areas: Work in Progress (WIP): As WIP represents what has not yet been billed for a project, billing on a regular basis helps reduce the amount of WIP your firm shows on its books. This makes the reverse true as well – inconsistent billing causes your WIP value to increase.Not billing regularly can also lead to your profit or loss taking a hit when needing to write off outstanding WIP that can no longer be billed. Essentially, if you’re billing a client too long after the work for that bill was completed, it’s possible the client may deny that charge. But if you bill on a regular basis, you can avoid this potentially uncomfortable back and forth with clients altogether. Days Sales Outstanding (DSO): One of the most important KPIs used to benchmark cash collection is DSO, and the part of billing that impacts DSO is your invoices. If your invoices are accurate and complete, then it makes the process of a client’s approval for payment much quicker and easier. Faster approvals lead to getting paid sooner, which decreases your outstanding receivables, and positively impacts DSO by reducing it. Conclusion While improvements in your billing process can help lower your firm’s WIP account balance and reduce DSO, it can also lead to a better relationship with your clients. When your client’s Accounting department can rely on the accuracy and timeliness of your billing practices – that’s going to make one happy client. Don’t underestimate how much of a factor that will play in their decision for awarding future project work. The impact on client satisfaction alone should be a good enough reason to improve your firm’s billing processes. Interested in learning more about the billing process? Check out The Ultimate ERP Glossary for AEC Firms, which includes 150 terms that will help you learn not just about billing, but about the entire project lifecycle. Download your free copy by clicking below! DOWNLOAD GLOSSARY NOW

DSO and DPO – What’s the Difference?

Gary Dwyer
GaryDwyer
Product Director
BST Global
Analyzing Days Sales Outstanding (DSO) and Days Payable Outstanding (DPO) can improve one very important financial metric for your AEC firm: cashflow. What It Is Before I get into how to calculate DSO and DPO, and how the resulting value of each impacts your firm’s cashflow, let’s do a quick refresher on their definitions: Days Sales Outstanding shows how well your firm is managing its accounts receivable by measuring how long it takes to collect payments owed to your firm. Days Payable Outstanding shows how well your firm is managing its accounts payable by measuring the average number of days it takes you to pay vendors. In short, DSO helps your firm see how long it’s taking to collect outstanding payments, and DPO helps your firm see how long it’s taking to pay outstanding bills. And while they address different areas, the information derived from each are equally as important. Now that you’re caught up on what DSO and DPO means, let’s look at the formula for each. How to Calculate DSO Credit SalesA purchase made that does not require the payment to be made in full at the time of purchase. The full amount can be paid at some point in the future or smaller regular payments can be made over a period of time. DSO is calculated by dividing your accounts receivable during a particular time period by the value of your credit sales during that same time period, and then multiplying the result by the number of days in the period. Here’s a quick example: Receivables: $2,000,000 Credit Sales: $2,800,000 Days in Period: 91 days DSO Calculation: ($2,000,000 / $2,800,000) x 91 days = 65 days Your firm should be aiming to have as low of a DSO value as possible because it indicates that you’re doing an excellent job of collecting outstanding debts. A range between the lower 50’s to upper 80’s is a typical value for most AEC firms. But once values start creeping over the upper 80’s, this should be a clear red flag to your firm. How to Calculate DPO DPO is calculated by dividing your average accounts payable by your daily cost of sales (also sometimes referred to as cost of goods sold or COGS). For example: Payables: $250,000 Cost of Sales: $1,250,000 DPO Calculation: $250,000 / ($1,250,000 / 365 days) = 73 days Unlike DSO, you want your DPO value to be higher because it means you can keep cash within your firm for longer. In this case, a range from the mid 60’s to more than 100 would be typical for most AEC firms. DSO and DPO Target Values But having a low DSO value, or a high DPO value, doesn’t give you the whole story. The target values for any firm are influenced by several factors, such as: what industry your firm is in, the type of projects your firm works on, whether that work is public or private, whether your firm is working as a general contractor or a sub-contractor, etc. So, what may be a target value for one architecture, engineering, or environmental consulting (AEC) firm, may be different for another. For example, if your firm does more private than public work, then the DSO target may be higher as you have room to negotiate more favorable progress payments (e.g. get advance payments), which helps reduce your firm’s DSO. But as you calculate your firm’s DSO and DPO values, keep in mind that while a single value is an important indicator to start paying closer attention, the benefit really comes from tracking these values over time. These values cannot be changed overnight – there are processes that need to be put in place and tested in order to see those values start to come down or go up. Depending on which direction the trend moves, it will have a positive or a negative impact on your firm’s available working capital – which is why these calculations are so important to understand. More on this in the next section. Why It’s Important Monitoring the trend of DSO and DPO values provides an insight into how your AEC firm manages its cash. Let’s see just how a positive or negative trend can have an impact. First off, an increase in your firm’s DSO means you’re financing clients by carrying their debt on your books – this results in a negative impact on your firm’s cash flow since it’s taking longer to collect those payments. Pay When PaidA contractual clause that stipulates that a contractor is obligated to pay its subcontractors upon receipt of payment from the owner. The same impact on your firm’s cash flow happens if your DPO is declining – meaning, cash may be going out sooner than it needs to be. This can be improved by making sure your firm negotiates more favorable payment terms with vendors and pays vendors according to those terms (not paying them earlier than what’s in the agreement), or it can even adopt a Pay When Paid strategy with vendors. Conversely, a reduction in your firm’s DSO, and an increase in DPO, will lead to improved cash flow for your business. As your firm starts collecting payments more quickly and takes longer to make payments (within reason, of course – you don’t want to ruin the relationship with your vendors!), the amount of cash coming in will exceed the amount going out. Even the smallest improvements in these factors can have an impact on the amount of working capital your firm has at a given time – so don’t take these lightly, make them a priority. Conclusion DSO and DPO are useful formulas for analyzing your firm’s processes (i.e. billing, collections, and payment processes) and can play a direct role in the effectiveness of your cash cycle. Given the significant role cash plays in successfully running a business, monitoring your DSO and DPO values can help your firm find ways to collect on outstanding bills as quickly as possible, while also watching outflows of cash for vendor payments. Want to learn other helpful calculations to keep your firm’s finances in check? Check out The Ultimate ERP Glossary for AEC Firms, where you’ll learn 150 terms (along with a whole range of AEC related formulas) that cover the entire project lifecycle. Download your free copy by clicking below! DOWNLOAD GLOSSARY NOW