How is this for guaranteed failure – using DSO as a measurement tool!
We give customers terms, for example 30 days. How long do they actually take to pay – on the average? We may determine that between 35 and 40 days is a good objective for the credit manager and his team.
Why it fails?
Before anyone is involved in setting objectives in business, financial or otherwise, ‘The Greatest Management Principal in the World’ by Michel Le Boeuf is required reading. He covers it in a lot of detail but simply put: ‘people will do what they are rewarded for’. That is it – not what you want or what you ask – but what you reward.
There is a well-known story of a CEO who told his credit manager that he would receive a percentage of the collections he made for all accounts that were 90 days past due. Did it focus his efforts on 90 days? Yes it did, but at the expense of everything else. What kind of shape were the receivables in 60 or even 30 days? It wasn’t that he didn’t care – just not very much.
You tend to get what you measure – but what you measure may not be what you want. Who says 35 to 40 days is a good idea? Not the sales department who are trying to land a new customer or expand into a challenging market. Customer service won’t think it such a great target for specific situations or customers. Yet, it is not a good idea either to have sales or customer service set the objective for collections either.
Credit expert Declan Flood (The Credit Coach, located in Dublin), says that when a sales representative enthusiastically brings in a new order with special terms that will challenge the DSO, there appear to be only two options:
1.) The sales manager wins the battle and the order is delivered.
2.) The credit manager wins the battle and the order is not delivered.
Appearances can be deceiving. A third option is to do the math. What is the bottom line profit to the company, including the additional cost of financing? Are we making a good profit and they are a good credit risk? ‘If yes, have at it,’ says Declan, ‘and adjust objectives accordingly.’ The objectives are set to serve you, not the other way around. What do you want to achieve? Some firms need to reduce errors or defects, increase their cash flow, reduce bad debt or perhaps maintain bad debt but reduce costs, increase sales, expand into new and challenging markets.
While we would like to have a single and simple objective such as DSO, business is complicated and often calls for more than one objective and they need to be flexible, particularly in this day and age of quickly changing international economies. That means a lot more work on our part, but of course, that is why they pay us the big bucks, eh?
This means multiple objectives that are flexible.