How accounts receivable operates has evolved greatly, but how success is measured has remained fairly static. There are dozens of metrics that can be tracked that can give you a full picture of your business performance, but some are a little more important than others.
These metrics are the most important you can follow and will give you a full idea of the effectiveness of your AR operation.
Days Sales Outstanding (DSO)
DSO is the measurement of the size of outstanding accounts receivable. It’s a reflection of how quickly a company is able to collect money, which shows its efficiency and profitability.
From a business standpoint, it shows which companies are able to resist providing free credit to customers and clients and reinvest earnings into growing the enterprise. A low DSO reflects a company that collects payments on time. A high DSO is the opposite.
Equation
(Accounts Receivable / Total Credit Sales) x Number of Days
So, a company with $40,000 in AR and $100,000 in credit sales for the month of June would be:
(40,000 / 100,000) x 30 = 12 days
Fun fact: Many experts say your DSO should be 20-25% higher than your standard payment terms.
Average Days Delinquent (ADD)
ADD calculates how long it takes an invoice to be paid, measuring the average time from a due date to the actual date of payment. It’s an easy way to look at how effective your AR operation is.
It’s best to view ADD and DSO together. If they are at similar levels and trending in the same direction, you’re AR operations are likely driving the improvement or decline. If there is a significant difference or they’re trending differently, you should probably take a deep dive into what is causing the discrepancy.
Equation
DSO (see above) – Best Possible Days Sales Outstanding (BDSO)
You may also consider using Days Beyond Term, the average number of days your overdue invoices have been delinquent. This looks at your most tardy customers.
Equation
(Dollars 1-30 days overdue x 15) + (Dollars 30-60 days overdue x 45) + (Dollars 60-90 days overdue x 75) + (Dollars 90+ days overdue x 105) / Total Outstanding AR
Turnover Ratio
This measures how efficiently a company collects payments. It shows how effective a company extends credit and then collects on it. The higher the number is, the better the organization is performing.
Equation
Net Credit Sales / Average Accounts Receivable
Net credit sales are sales where money is collected at a later date. It can be calculated by:
Sales on Credit – Sales Returns – Sales Allowances
Average Accounts Receivable is calculated by: (Starting AR + Ending AR for a period of time / 2
Collection Effectiveness Index (CEI)
CEI is a relatively new metric and serves as a more granular and precise version of DSO. Like DSO, it measures how effective your AR department is at collecting payments. There are differences, however.
DSO looks at how effective AR operations are over a limited period of time, such as a month or a quarter. Itself is a measurement of time.
CEI is more of a long-term look and typically measures effectiveness over at least a one-year period. Unlike DSO, CEI is not a measurement of time, but a metric of the overall effectiveness of your collections efforts.
Equation
CEI can be measured by:
((Beginning Receivables + Monthly Credit Sales – Ending Total Receivables) / (Beginning Receivables + Monthly Credit Sales – Ending Current Receivables)) x 100
There are of course many different ways to measure your A/R and broader financial performance. When thinking about which ones that are most important to track for your business be sure to consider which ones have the strongest ties to overall business performance metrics. Doing that will ensure that the KPIs you’re focused on measuring and improving align with what matters most for the company.
