Most Accounts Receivable teams use DSO as the main KPI to measure their performance. By extension, most A/R invoice-to-cash management platforms and teams base their key performance indicators (KPIs) on the measurement of Days Sales Outstanding, or DSO. But DSO is not an accurate reflection of delinquency, because it starts its calculation from the time that the invoice is issued rather than the due date.
In this post, we’ll explain the problems with the traditional metrics and offer alternative metrics for measuring A/R performance.
Why the Traditional DSO Metric is Not Useful
So how do you select the right KPIs for your A/R team? First, you’ll need to understand the metric that most A/R teams and platforms base their KPIs on: DSO. Traditionally, days sales outstanding (DSO) measures the average number of days that it takes to collect payment from customers after a sale has been made and the invoice is issued.
To calculate traditional DSO, take the total A/R balance sheet, divide it by your total sales and multiply the quotient by the number of days in the period you want to measure.
Days Sales Outstanding = (Accounts Receivable / Total Credit Sales) x Number of Days
The problem with this metric is that it is based on the day that the invoice was issued, rather than the date that the invoice is due. As a result, it is not an accurate metric of delinquency as it doesn’t take the due date or payment terms into account. For example, since each company has different payment terms (e.g, 30, 60 or 90 days), a high DSO of 90 might seem to be problematic at first glance, but once you understand that the company has a payment term of 90 days, you realize that the “high” number doesn’t mean the customer is delinquent for that company.
5 Key A/R Performance Metrics to Track
Since DSO doesn’t accurately measure delinquency and forms the basis for many classic A/R metrics, it creates additional metrics that aren’t very useful as well.
Here are four KPIs that aren’t based on DSO that you can use to measure A/R performance:
1. Actual Median Days Delinquent (MDD)
The MDD measures the number of days from the date the invoice is due to the date the invoice was paid for all late payments and calculates the median number of days. Measuring the median days rather than the average helps to cancel outliers and more accurately identify any period that the organization is performing outside of its average performance.
2. Collection Rate
The collection rate, or Collection Effectiveness Index (CEI) is a measure of how well you’re collecting outstanding payments within a specific period. It’s a comparison of how much you were owed at the beginning of the period versus how much you actually collected during that same period.
This number is displayed as a percentage:
Collection Effectiveness Index = (Beginning Receivables + Monthly Credit Sales – Ending Total Receivables) / (Beginning Receivables + Monthly Credit Sales – Ending Current Receivables) x 100
3. Collection Rate Trend Analysis
This KPI measures the collection rate of the team during different periods to identify patterns or trends. It allows managers to monitor any fluctuations in team performance so that they can examine more thoroughly if any drop in performance is due to problematic accounts, a non-optimal A/R collection process, individual team members, or a combination of these and other factors. It can also be used to praise performance that is beyond average and attribute it to any outstanding team members, if relevant.
4. Time-Limited Aging Buckets
Aging buckets display a breakdown of different invoices according to different time periods. They help managers identify which invoices have been outstanding the longest so that they can prioritize the collections of these invoices before others. Managers could create a KPI based on aging buckets that helps to gauge both team and individual performance. For example, they could create a KPI that limits aging buckets to invoices that are only past a specific date (e.g., no aging buckets longer than a 3-month period) or a KPI that certain aging buckets decrease within a specified time period (e.g., all 90+ aging buckets should decrease by 20% in Q1). These are only a few examples of the KPIs managers might use based on aging buckets to measure team performance.
5. Percentage of Invoices Paid through the Payment Gateway
If your A/R platform includes a payment gateway and one of the goals for your collections team is to encourage as many customers as possible to pay through the gateway, you can set up a KPI with the goal of a specific percentage of invoices or receivables paid through your payment gateway during a specific period (e.g, 50% of invoices paid through the payment gateway for Q4). An additional benefit: Payments through the gateway allow automatic invoice matching through a solution such as Gaviti’s Cash Application.
How Gaviti Helps You Track Accounts Receivable Performance Metrics
Another challenge with traditional A/R metrics is that while they measure team performance, they aren’t able to measure the performance of individual team members. With an integrated A/R invoice-to-cash platform like Gaviti, you can automatically and accurately track metrics such as the ones above on both an individual and team level, rewarding high-performing members of your collections team and offering assistance and motivation to those who might need it. By streamlining the entire A/R process rather than just the collections process, you’ll also gain insights into the complete A/R process, from evaluating a prospective customer’s credit rating to providing credit, collecting invoices, managing disputes and managing cash application.
If you’re ready to learn more about how you can track your team and individual performance metrics, book a demo today to get started with Gaviti’s automated A/R invoice-to-cash platform.