Every company needs good accounts receivable management. But how do you know you’re getting it? Like just about everything else, your management of this task can be measured—and it should be.
And, much like everything else you use metrics for, you’re going to need to choose how to measure the performance of your accounts receivable. There are plenty of metrics available; which ones should you be using for the task?
1. Turnover Ratio
Your turnover ratio measures how often your team collects accounts over a one-year period. To calculate it, take your credit sales from your income statement and divide over the outstanding accounts on your balance sheet.
A high ratio indicates your team is effectively and efficiently collecting accounts on a regular basis, while a low ratio suggests you could improve in this area. It may be time to revisit your credit or collections policies.
2. Collections Effectiveness Index
The collections effectiveness index (CEI) should be used in tandem with the turnover ratio. While the turnover ratio tells you how often collections happened, the CEI tells you what percentage of your accounts receivable was collected over a particular period, often one year.
Much like the turnover ratio, a high number here indicates your accounts receivable management is effective; the closer to 100 percent you get, the more of your accounts you’re collecting.
A low number is cause for concern, and you may want to look into potential issues. Is your team understaffed or using outdated technology? You may also need to reassess how you extend credit or deal with overdue accounts.
If you track this measure over time, you’ll be able to chart improvements in your team’s performance. To calculate CEI, first add your monthly credit sales to your beginning receivables and subtract your ending total receivables. You’ll take the result and divide it over the sum of your beginning receivables plus monthly credit sales, less your ending current receivables.
3. Days Sales Outstanding
Getting a yearly report on your accounts receivable management is important, but it’s also a good idea to take snapshots over shorter periods of time. The days sales outstanding (DSO) measure helps you look at specific timeframes to see how your team is performing at a particular point in time.
Over time, as you collect multiple snapshots, you can compare your DSOs for improvements or decreases in performance. Monitor the environment as well—what changed? If there was an improvement, what caused it?
DSO also gives you insight into how long it’s taking to collect on invoices once you’ve issued them. The higher the number, the longer it’s taking you to get paid.
To calculate DSO, divide your accounts receivable over your total credit sales and multiply by the number of days in your measurement period, for example, 31 for the month of March.
4. Average Days Delinquent
Average days delinquent (ADD) gives you a measure of just how long it’s taking your customers to pay you after their bills become overdue. A low number means your customers pay you relatively quickly once their bills are overdue; it could mean your team is efficiently following up with them or sending out reminder notices in a timely manner.
A high ADD measure means it’s taking your customers a long time to pay their overdue bills, which could indicate a number of problems, not just with your accounts receivable management, but within the customer base itself. High ADD might be caused by understaffing, which makes it difficult for your team to send reminders or it could indicate you need to revisit your policies about whom to extend credit to.