As business becomes more global and functions within an organization become involved in multiple aspects of the business, metrics and analytics become increasingly important.
But here’s the problem: you can’t manage what you can’t measure. Since management of cash flow and working capital can create a make-or-break business environment, it is absolutely essential that Finance (AP, AR, and Treasury) are able to monitor the metrics that will tell your business’s unique story. Knowing which key metrics need to be looked at for each function is a vital step in improving your business’s performance.
When it comes to accounts receivable (AR), companies need to perform a historical trend analysis of AR aging and days sales outstanding (DSO) by month for the last two fiscal years and the current year. To do that, they need to capture and analyze five key metrics.
5 Key Metrics to Assess Your AR Performance
Days Sales Outstanding (DSO)
This is the baseline performance metric that Finance needs to look at to track how long it takes on average to collect payments based on the date an invoice is sent as well as on negotiated terms. Top-performing companies have a DSO that is less than 30 days, so the ultimate goal is to get your DSO as close to that number of days as possible. The calculation for DSO is accounts receivable/total credit sales x number of days in the period.
Average Days Delinquent (ADD)
This metric, which indicates how many days on average payments are overdue, can offer hints to other potential problems. You want this number to be as low as possible…to get to a point where you are at your best possible DSO. Obviously you want customers to pay on time (even quicker than that, if possible), but when the ADD gets too high, there are a couple of things to consider. Are you short-staffed, with too few people handling receivables? Should you be looking at changing your invoicing and receivables processes? These are questions that need to be considered and answered if your ADD is too high.
Accounts Receivable Turnover Ratio (ART)
This metric measures the effectiveness of your AR when it comes to collecting revenue. The goal is to learn how often the company converts accounts into cash over a set period, usually over one year. The ART is calculated by dividing your net credit sales (sales where cash is collected at a later date) by your average accounts receivable (the sum of starting and ending accounts receivable over a time period divided by 2). So net credit sales/average accounts receivable will give you the ratio. When your ration is high, you are turning AR into cash more frequently, thus improving your cash flow and liquidity.
Collection Effectiveness Index (CEI)
Whereas the ART measures how often accounts turn over, CEI measures how many accounts turn over. By measuring how much money was owed and how much of it was actually collected over a given period of time, you are also able to measure the effectiveness of your collections performance over that same time period. You may find that your current collections policies and procedures are under-performing and can then decide whether or not changes need to be made.
Number of Revised Invoices
Your business rises and falls on your ability to get invoices out to your customers as quickly and as accurately as possible and then to follow up to ensure you collect payments in the agreed upon date or earlier. I point out “as accurately as possible” because few things will slow down payments more than having to revise inaccurate invoices. The amount of time lost is only one of the concerns. Customers are also impacted when their AP departments have to go back and forth to get the corrected invoices.
These metrics allow you to measure the performance of your AR team, but they also do much more. You can dig down deeper into the individual payment history to reveal whether or not a specific late-paying customer has credit issues that prevent them from paying. You might want to reassess the terms with that customer or even question whether further business is advisable.
When it comes to your processes, especially in the case of the number of invoices revised, you may want to consider automating some or all of your AR processes, from invoice preparation to collections. Relying on paper and manual processes too often leads to human error and delays in payment. In a global environment where time is money, and where many employees are working in a more distributed fashion than ever before — without physical access to traditional mail rooms, or each other — and where every dollar needs to be accounted for in as short a time span as possible, digitizing and automating your AR may be a way to significantly improve the overall performance of your AR team.