Important metrics and KPIs that gauge the health of A/R management.
It’s important to monitor accounts receivable with standardized key performance indicators, or KPIs. KPIs provide guideposts by which to measure the health of accounts receivable and company cash flow. Accounts receivable KPIs also gather pertinent ongoing data that can be used to further inform credit and collections policies and decisions.
Like any measurement tool, refinement is critical. As A/R data accumulates, you’ll have a better idea of what data best reflects the information you need to succeed. A nice thing about setting KPIs is the flexibility. While benchmarks should remain somewhat consistent, KPIs can and should be revisited regularly and refined for the most accurate picture.
Here are common KPIs to monitor when managing your accounts receivable:
Days Sales Outstanding (DSO)
How quickly does collection occur after the sale is complete? What is the average collection period? Days Sales Outstanding (DSO) measures the health of collections at any given time, by measuring the time it takes to collect credit sales (not cash).
How to calculate DSO:
DSO = (A/R / Total credit sales) x number of days in pay period
When DSO is less than 50% of the payment terms (due dates), accounts receivable are considered “healthy” and within 3-5 days great. Keep in mind DSO may fluctuate depending on your business season’s highs and lows, market activity, and other short-terms circumstances. This is why the longer DSO data is collected, the more accurate picture you’ll get of your business, and the better decisions you can make.
It’s important, however, not to measure apples to oranges. To determine a healthy DSO for your business, find your industry’s standard DSO to provide competitive benchmarks.
Best Possible Days Sales Outstanding
While DSO provides a good look at the efficiency of A/R, the Best possible DSO offers insight into how delinquent accounts are affecting cash flow. To calculate this figure, you must know:
- Current receivables
- Total credit sales per given period
- Number of days per given period
How to calculate Best Possible DSO:
BPDSO = (Current receivables / Total credit sales) x number of days in pay period
Average Days Delinquent (ADD)
The average days delinquent also measures the efficiency and effectiveness of A/R collections.
How to calculate ADD:
ADD = DSO - Best Possible DSO
When ADD & DSO are moving together simultaneously, meaning both are heading up or both are heading down, the information is pretty cut and dried: Things are really working (up), or they most definitely are not (down).
If ADD & DSO move in different directions, something may be awry. You’ll have to do some digging around to find the source of the discrepancies.
If DSO rises, while ADD falls, the upswing in DSO is probably not due to more efficient collections. The rise could be due to other reasons such as shorter months (payment cycles), seasonality, or changes in customers’ credit terms.
Collection Effectiveness Index (CEI)
The CEI is pretty straightforward: How much money was owed, and how much was collected during any given period? This percentage is a good measure of how effective your current collection policies are, and whether or not they need to be revisited.
CEI measures how effective your collections process is over the long-term, which can be a better gauge of overall quality than DSO.
How to calculate CEI:
CEI = (Beginning receivables + monthly credit sales - ending total receivables)
(Beginning receivables + monthly credit sales - ending current receivables)
The closer to 100% or total, the better your collections process. Paying attention to whether CEI is increasing or decreasing can help you gauge your collections procedures, and should be monitored regularly.
Accounts Receivable Turnover Ratio (ART)
How often can your company turn A/R into cash? This is the “Art” of successfully managing accounts receivable.
How to calculate ART:
ART = Net credit sales / average accounts receivable
The higher the ART number, the healthier the cash flow.
Another thing to analyze on a regular basis is the number of revised invoices generated. While a few revised invoices are to be expected, too many could signal an issue: inaccuracies due to working too quickly, careless accounting mistakes, faulty software, or dishonest employees, to name a few.
How to Improve A/R Performance
Once KPIs are gathered and evaluated, take steps to correct critical issues. To improve A/R performance , consider:
- Electronic invoices
- Automating A/R with industry standard software
- Outsourcing A/R to experts, such as IBS
Which KPIs do you use to monitor accounts receivable? How do you measure the health of your A/R department?