The secret to accounts receivable management is knowing how to track and measure its performance. You can’t just look at the final balance sheet and guess which areas need improvement. You need to measure the right key performance indicators (KPIs).
Key performance indicators are specific, measurable values that evaluate the success of a process. They can show you exactly where you need to make improvements to optimize your accounts receivable collections efficiency and maintain a healthy cash flow.
To create more efficient A/R collections processes, here are four A/R KPI metrics you should be tracking.
Days Sales Outstanding (DSO)
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 it’s one of the most important collections KPI metrics to track.
To calculate 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
DSO is a great way to judge your collections performance. If your DSO is high, it means your customers take a long time to pay and could indicate your collections process needs work. Leaving too much money outstanding can hurt cash flow.
Best Possible DSO
How do you know if your DSO is too high? By calculating the best possible DSO. This will show you how long your on-time customers take to pay invoices.
Best Possible DSO = (Current Receivables x Days in Period) / Total Credit Sales
Ideally, you want your actual DSO and best possible DSO to match, but that’s nearly impossible in reality. The fact is you shouldn’t always expect to get paid before the invoice term. So when taking a look at Best Possible DSO, try to at least keep the number within half of your actual DSO. For example, if your best possible DSO is 30, keep your actual DSO under 60.
Average Days Delinquent (ADD)
Average days delinquent is the difference between your DSO and best possible DSO. It shows you how effectively you can collect receivables on time.
Average Days Delinquent = Days Sales Outstanding – Best Possible DSO
With ADD, you want the number to be as small as possible. The lower your ADD, the closer you are to your best possible days sales outstanding.
Collective Effectiveness Index (CEI)
Collective effectiveness index (CEI) is a measure of how well you’re collecting outstanding payments within a specific period.
The formula might seem complex, but it’s basically a comparison of how much you were owed at the beginning of the period and how much you collected by the end displayed as a percentage:
Collective Effectiveness Index = (Beginning Receivables + Monthly Credit Sales – Ending Total Receivables) / (Beginning Receivables + Monthly Credit Sales – Ending Current Receivables) x 100
The goal is 100% CEI. That means you collected all outstanding payments within the time period. The higher the percentage, the more effective your collections processes.
It’s important to measure CEI over time to identify trends. Major dips could indicate a problem with your collections.
Accounts Receivable Turnover Ratio (ART)
Accounts receivable turnover ratio (ART) measures your ability to turn accounts receivable into cash over a specific period—usually over a year. This metric shows your cash flow and liquidity, two things that any business should want to keep track of.
Accounts Receivable Turnover Ratio = Net Credit Sales / Average Accounts Receivable
A higher ART ratio means you can turn A/R into cash faster and more frequently. For example, if your ART ratio is three, that means you can collect your average A/R three times per year.
How Automation Can Improve Accounts Receivable Management
Keeping track of all these various A/R performance metrics can be tough if you rely on manual processes. Not only is it complicated and time-consuming, but it also leaves room for human error.
By using an automated A/R collections platform like Gaviti, you can automatically and accurately track these important KPIs and vastly improve your overall collections performance. There’s no better way to optimize your A/R efficiency.
If you’re ready to significantly boost your cash flow and simplify accounts receivable management, contact us today to get started with Gaviti’s automated A/R collections platform.