A quality accounts receivable operation is constantly looking at how it is performing, using data to determine what is working, what isn’t working, and why. A deep analysis of A/R will unveil efficiencies that may not be obvious and allow your business to do more without adding resources.
The end result of this process is improved cash flow, which helps enable you to expand your business. A proper and consistent understanding of the effectiveness of your A/R operations doesn’t require a significant amount of resources, but the benefits could have a wide-ranging impact on your business.
What Does it Mean to Have Quality Accounts Receivables?
How do you know if your A/R accounts are considered “good”? What makes for a good account and what makes for a poor one? The easy way of determining is answering, “how likely is it that this customer will pay me?”
A variety of factors can play into this. Things like payment history, size of debt, and length of business relationship will play a difference. If you have a customer that you’ve done business with for a decade and rarely makes late payments, you can consider them reliable and feel comfortable making business decisions that count on that account being paid in full.
On the other side, young or unreliable accounts are considered contra asset accounts, which have a zero or negative balance. It’s a method for accounting for questionable or doubtful accounts and reduces the amount of variables on your balance sheet. Contra asset accounts can be considered bad debts and the fewer your have the better.
How to Analyze Accounts Receivable
There are several generally accepted formulas that can be used as key performance indicators for A/R operations. These will measure and track liquidity, efficiency, profitability, and more and give an easy-to-digest view of performance.
Average Collection Period
Average collection period measures the time it takes for a business to receive payments. It is usually used to track the amount of cash available on hand and is best used by companies that require a healthy cash flow.
A/R Balance/Total Net Sales (x 365)
A company records a yearly A/R balance of $100,000 and logs $300,000 in net sales. You would calculate the average collection period as:
100,000/300,000 (x365) = 121.67
Accounts Receivable Turnover
Accounts receivable turnover reflects how often per year that a business collects its average accounts receivable. It is a measure of how efficiently you collect on the credit provided to customers.
Net Credit Sales/Average Accounts Receivable
A company, after returns, has net credit sales of $150,000 and the average accounts receivable for a year is $25,000.
150,000/25,000 = 6
Days Sales Outstanding
Days sales outstanding (DSO) shows the average number of days it takes to collect payment on an account. It shows if a company is extending credit to customers too much, or too little.
(Total A/R / Total Credit Sales) x Number of Days
For 30 days, a company has a total A/R of $500,000 and extends credit on sales worth $250,000.
(500,000 / 250,000) x 30 = 60
Collection Effectiveness Index
Collection effectiveness index (CEI) measures how effective you are at collecting on customer accounts. It’s a more precise measurement than DSO and the two are often grouped together.
(Beginning Receivables + Monthly Credit Sales - Ending Total Receivables) / Beginning Receivables + Monthly Credit Sales - Ending Current Receivables) x 100
For 30 days, a company begins a month with $500,000 in sales, extends $100,000 in credit sales, and ends the month with total receivables of $200,000 and has current receivables of $300,000.
(500,000 + 100,000 - 200,000) / (500,000 + 100,000 - 300,000) x 100 = 88.9
These aren’t the only metrics that matter, but they’re some of the most commonly used. You may also consider trend analysis reporting to get a better idea of revenue projections. For A/R, track the receivables balance at the end of each month and use that to see if you are improving or falling behind. It’s also useful for tracking bad debts and can bubble up concerns before they become significant issues.
The Invoiced platform makes following these kinds of trends simple. Cash flow forecasting is included in the software, making it easier to make monthly, quarterly, or yearly planning.
Improve Your Cash Flow with Invoiced
If you are having problems maintaining a consistent cash flow, Invoiced can help. We’ve helped customers in dozens of industries automate their A/R operations and get paid quicker while using fewer resources.