3 Axes of Revenue Management
While it is important to manage DSO, for certain types of businesses DSO management might not make much sense as bulk of issues could be revolving around operational revenue management than the collection from sale proceeds. For example, if your business does a lot of fixed price contracts where it is outcome driven or if your business does a lot of engineering/construction related work or if you basically are in a business where you collect the fees upfront for the work to be done, then in such cases Revenue Management will require looking beyond DSOs alone.
Going beyond DSOs require us to understand the Revenue Recognition policy. Generally at a high level there are 3 kinds of revenue. Deferred Revenue, Accrued Revenue and Billed Revenue. Lot of companies depending on the business they are in, fit into any of these 3 models here. Larger groups could have a mix of all 3.
Deferred Revenue is something that comes where customers pay in advance for the product/service to be delivered. So, Cash comes early while Revenue follows either on POC (Percent Completion) basis or ETC (Expected Time to Close) basis. In Deferred Revenue, operational efficiency in completing or delivering is more important than the Cash itself. Deferred Revenue is generally recorded on the Liability side as the Cash collected is a liability till the service/product is delivered.
Accrued Revenue is lot more common. Accrued Revenue is a Revenue where Revenue is accounted in the books first while invoicing could follow later. In Accrued Revenue, the ability to convert the accrual to billed is what requires more tracking than the DSO itself. Sometimes conversion of Accrual to billed itself could take months or years depending on the type of contract. While DSOs could be low, if the conversion days from Accrual to Billed is higher, then it could cause significant cash challenges which DSO cannot convey when looked at in isolation.
It's important that the 3 ratios of DSO, Deferred Revenue to Revenue Conversion in Days & Accrued Revenue to Revenue Conversion in Days are all tracked in parallel to effectively manage and measure a business.
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