Implementing Effective Accounts Receivables Collection KPIs to Improve Cashflow

Effective AR (Accounts Receivable) collection measures are essential to maintain a healthy cash flow for any business.

By monitoring and managing accounts receivable, companies can ensure that they receive payment for goods or services rendered on time.

In this article, we will explore various AR collection measures businesses can implement to improve their cash flow and reduce the risk of bad debt.

The accounts receivable department plays a crucial role in the financial stability of a company, as outstanding invoices directly impact the cash flow.?

A robust AR collection process involves:

·???????Regular follow-up with customers.

·???????Efficient tracking of payment status.

·???????Prompt resolution of any issues that may arise.

In addition, implementing the right AR collection measures can help a business maintain strong relationships with its customers while reducing the risk of extended payment cycles or bad debt.

To achieve this balance, finding the right blend of personal communication and automation is crucial, which can optimise the collection process and ensure consistent results. Whether setting up payment reminders or creating a clearly defined escalation process, the right AR collection measures can make all the difference in maintaining a healthy cash flow.

We will discuss in detail the following measures for the AR Collection and AR Team of a business:

·???????Collection Effectiveness Index (CEI)

·???????DSO – Days Sales Outstanding or Average collection period

·???????Best possible DSO

·???????Delinquent DSO or Average days delinquent

·???????Active customer accounts per credit and collection employee

·???????Operating cost per employee

DSO (Days Sales Outstanding) is a key performance indicator (KPI) used to measure the effectiveness of a company's accounts receivable (AR) collection efforts. It calculates a company's average days to collect payment after a sale. A lower DSO indicates a more efficient and effective collection process, as the company receives compensation sooner.

For example, if a company generates $100,000 in sales in a month and has $80,000 in accounts receivable at the end of the month, its DSO would be calculated as follows:

$80,000 / ($100,000 / 30 days) = 26.67 days

In this example, the company can collect payment in an average of 26.67 days after the sale. Therefore, a lower DSO of 15 days indicates a more efficient collection process.

The Collection Effectiveness Index (CEI) is another valuable KPI that measures the effectiveness of a company's AR collection process. CEI is calculated by dividing the amount of cash collected within a given period by the total amount of accounts receivable outstanding during the same period. This KPI provides a more comprehensive view of a company's collection efforts, as it considers the speed at which payment is received and the amount collected.

For instance, let's say a company has $100,000 in accounts receivable and collects $80,000 within the month. Its CEI would be calculated as follows:

$80,000 / $100,000 = 0.8 or 80%

In this example, the company has a CEI of 80%, indicating that it could collect 80% of its outstanding accounts receivable within the month. A higher CEI, such as 95%, would show a more effective collection process, as the company can collect a larger percentage of its outstanding accounts receivable.

CEI provides valuable insights into the overall performance of a company's AR collection process. It reflects not just the speed of payment but also the effectiveness of the company's efforts in collecting the owed amount.

Both DSO and CEI are important KPIs for measuring the effectiveness of a company's AR collection efforts. While DSO provides insights into the speed of payment, CEI offers a more comprehensive view by considering both the speed and amount of payment collected.

On the one hand, a low DSO is crucial as it means a company receives payment sooner and maintains a healthy cash flow. On the other hand, a low DSO alone may only sometimes be indicative of an effective collection process, as it does not consider the amount of payment received. For example, a company may receive payment quickly but only collect a small portion of the outstanding accounts receivable. In this case, the DSO would be low, but the CEI would be low, indicating an ineffective collection process.

On the other hand, a high CEI is desirable as it indicates a more effective collection process, where the company can collect a more significant percentage of its outstanding accounts receivable. However, CEI needs to provide information on the speed of payment, which is also an important aspect of the collection process.

Please look at the following example to better understand the importance of considering both DSO and CEI.

Company A has a DSO of 25 days and a CEI of 80%. These metrics suggest that the company receives payment quickly and effectively, collecting a significant portion of its outstanding accounts receivable. However, a closer look at the numbers reveals that the company only collects a small portion of its outstanding accounts receivable and relies heavily on a few large clients for its cash flow.

In contrast, Company B has a DSO of 30 days and a CEI of 75%. While its DSO is slightly higher, its CEI is lower, suggesting that the company is collecting a smaller portion of its outstanding accounts receivable. However, a closer look at the numbers reveals that the company is collecting a more diverse mix of smaller accounts, providing a more stable and secure cash flow.

In this example, Company A may have a more effective collection process based on its lower DSO, but its reliance on a few large clients makes its cash flow less secure. Conversely, company B may have a slightly slower collection process, but its more diversified accounts receivable provide a more stable and secure cash flow.

The example highlights the importance of considering both DSO and CEI when evaluating the effectiveness of a company's AR collection process. While DSO provides information on the speed of payment, CEI considers both the speed and amount of payment collected, providing a more comprehensive view of the collection process.

In conclusion, both DSO and CEI are valuable KPIs that provide complementary information on the effectiveness of a company's AR collection efforts. While DSO gives insights into the speed of payment, CEI provides a more comprehensive view by considering both the speed and amount of payment collected. Both KPIs are equally important and should be considered together to provide a complete picture of a company's collection process.

In addition to DSO and CEI, the "Best possible DSO" can also be used as a complementary KPI to measure the effectiveness of a company's AR collection process. The best possible DSO is the shortest amount of time it would take to receive a payment if all customers paid on time.

This KPI provides a benchmark against which a company's actual DSO can be compared. If the actual DSO is close to the best possible DSO, it suggests that the company receives payment as quickly as possible, indicating an effective collection process. However, if the actual DSO is significantly higher than the best possible DSO, it suggests that there is room for improvement in the collection process.

For example, consider a company with the best possible DSO of 30 days and an actual DSO of 45 days. The fact that the actual DSO is significantly higher than the best possible DSO suggests that there may be issues with the company's collection process preventing it from receiving payment as quickly as possible.

In conclusion, the best possible DSO provides valuable insights into the effectiveness of a company's AR collection process by serving as a benchmark against which the actual DSO can be compared. By comparing the actual DSO to the best possible DSO, a company can identify areas for improvement in its collection process and take steps to receive payment more quickly.

The delinquent DSO or average days delinquent KPI is important because it provides a clear picture of the effectiveness of a company's follow-up and enforcement processes. The longer it takes customers to pay after their payment is past due, the more complex and costly it becomes to collect the payment, which can negatively impact the company's cash flow. By tracking the average days delinquent, a company can identify trends and patterns in customer payment behaviour and take proactive steps to improve its follow-up and enforcement processes.

For example, suppose a company's average days delinquent is consistently increasing. In that case, it may indicate that its follow-up and enforcement processes are not working effectively and that the company needs to improve them. This could involve hiring additional staff to manage collections, enhancing technology for tracking and monitoring overdue accounts or implementing new procedures for follow-up and enforcement.

In conclusion, the delinquent DSO or average days delinquent is a crucial KPI for evaluating the effectiveness of a company's follow-up and enforcement processes for overdue accounts. By tracking and analysing this KPI, a company can identify trends and patterns in customer payment behaviour and take proactive steps to improve its collections processes and ensure timely payment from delinquent customers.

In addition to the KPIs already discussed, two other important KPIs for evaluating a company's AR collection process are "active customer accounts per credit and collection employee" and "operating cost per employee." These KPIs provide valuable insights into the efficiency and effectiveness of a company's credit and collection processes and can help identify areas for improvement.

The "active customer accounts per credit and collection employee" KPI measures the number of customer accounts each credit and collection employee is responsible for managing. A high number of accounts per employee can indicate that the company's credit and collection staff needs to be more active, which can lead to inefficiencies and increased operating costs. Conversely, a low number of accounts per employee can indicate that the company needs to utilise its staff effectively or that it needs to hire additional employees to manage its customer accounts.

The "operating cost per employee" KPI measures the cost of operating the credit and collection process for each employee. A high operating cost per employee can indicate that the company's processes could be more inefficient or overspending on its credit and collection activities. Conversely, a low operating cost per employee can indicate that the company is utilising its resources effectively and that its processes are efficient.

In conclusion, the KPIs "active customer accounts per credit and collection employee" and "operating cost per employee" provide valuable insights into the efficiency and effectiveness of a company's credit and collection processes. By tracking and analysing these KPIs, a company can identify areas for improvement and take steps to optimise its AR collection process and ensure efficient and effective collection of payments from its customers.

In conclusion, the KPIs discussed above provide a comprehensive view of a company's AR collection process. The Collection Effectiveness Index (CEI) measures the overall efficiency and effectiveness of a company's collection efforts. The DSO, or Days Sales Outstanding, measures the average time it takes for a company to collect payment from its customers. The "best possible DSO" and "delinquent DSO" provide additional context for the DSO by indicating the company's performance relative to its ideal performance and to its past performance, respectively. Finally, the "active customer accounts per credit and collection employee" and "operating cost per employee" KPIs provide insights into the company's staffing and operating efficiency.

By tracking and analysing these KPIs, a company can identify areas for improvement in its AR collection process and take steps to optimise its collection efforts. By doing so, the company can improve its cash flow and financial stability while ensuring prompt and efficient customer payment collection. In short, these KPIs provide a valuable toolkit for a company to assess and enhance the performance of its credit and collection processes.