A business’s cash flow depends on its ability to effectively manage accounts receivable (AR) and collections. But how do you know whether your accounting professionals are effective in their management processes or whether there is room for improvement? Continuously monitoring the performance of AR throughout the year will allow your business to collect performance snapshots that can provide insight into areas of strength, as well as early warning signs of trouble ahead. Not only that, AR performance metrics enable you to set specific, data-driven, measurable goals for AR and collections.
There are several metrics that can help you analyze various aspects of your AR practice; however, choosing which metrics are most appropriate for your business goals can feel daunting. Here are a few of the most common AR Key Performance Indicators (KPIs) and how they can be used to improve your company’s bottom line.
Which AR performance metrics to track
Accurately measuring the performance of your AR is the first step toward improving your business’ bottom line, but which metrics should be on your radar?
- Days Sales Outstanding (DSO): This metric tracks the amount of time it takes, on average, to collect payments. It is the standard, baseline metric that most businesses track. A high DSO is associated with a longer duration to collect payment, which may lead to cash flow problems. In general, businesses should aim for their DSO to not exceed their payment terms by more than half, if possible (e.g., payment terms of 30 days should aim for a DSO of no more than 45 days, for example).
DSO = (Accounts Receivable / total credit sales) x number of days in period
- Best Possible Days Sales Outstanding: This metric helps you measure how quickly you are collecting on invoices.
Best Possible DSO = (current receivables x number of days in period) / credit sales for period
- Average Days Delinquent (ADD): As the name suggests, ADD is the average number of days payments are overdue. The goal is to get this number as low as possible by encouraging clients to pay quickly.
ADD = days sales outstanding – best possible days sales outstanding
- Collection Effectiveness Index (CEI): This compares the funds collected over a given time period to the amount in receivables open for collection during that period. Monitoring CEI gives a good measure of collection effectiveness.
CEI = (beginning receivables + monthly credit sales – ending total receivables) / (beginning receivables + monthly credit sales – ending current receivables) x 100
- Accounts Receivable Turnover Ratio (ART): This shows cash flow by measuring how often AR are turned into cash. A high ratio suggests a high number of open accounts and unrealized revenue, which could mean it’s time to review credit or collections policies. In general, the more frequently you collect payment, the greater your cash flow and liquidity.
ART = net credit sales / average accounts receivable
- Number of Revised Invoices: It’s valuable to track how often invoices are revised. If the number of revisions is increasing, your accounts receivable department may need additional support (e.g., technology or additional staff to help reduce errors), or invoicing policies may need to be reviewed/revised. Invoice revisions create unnecessary delays in payment.
How to use your KPI measurements to improve AR management and collections
Now that you have identified the key performance metrics you want to track in your AR management process, it’s time to leverage this rich data to improve AR and collections. After all, monitoring KPIs is only beneficial if you use that information to make informed decisions and improvements.
If you find metrics are not where you’d like them to be, a starting point for improvement could be educating or reinforcing policy information, addressing any outstanding questions that may arise. Look at the existing bandwidth for your staff. Do you need additional resources to help support your AR processes? Focusing on internal areas for improvement can not only help with AR management, it can improve employee morale and productivity as well.
Another area to consider is your policies themselves. To improve performance, you may need to enforce or revise existing policies. You also could add electronic invoicing technology to help reduce invoicing errors and streamline processes.
Overall, by measuring key KPIs and using them to identify areas of strength and weakness within your AR process and business, you can improve the accuracy, timeliness, and effectiveness of policies and procedures, as well as improve customer satisfaction, employee productivity, and employee morale. It’s a win no matter which way you look at it.