Collection Effectiveness Index (CEI)
The collection effectiveness index provides a more accurate alternative to the days sales outstanding calculations. Like its rival, it measures the effectiveness of the accounts receivable team. It accomplishes this by comparing the amount of cash collected to the number of sales made on credit. Essentially, it tells you how much of your credit sales the A/R team successfully converts into cash.
How To Calculate Collection Effectiveness
Representing collection effectiveness as a percentage is much easier to interpret than the data produced by the DSO. Financial controllers aim for a CEI as close to 100% as possible.
Components of the Collection Effective Index
The formula contains several terms you must identify, understand and calculate before arriving at the CEI. Review the following:
- Beginning Receivables: This is the total amount of receivables at the beginning of the period you want to measure.
- Monthly Credit Sales: This is the total amount of credit sales made during the period you want to measure.
- Ending Total Receivables: This is the total balance of open receivables at the end of the period you want to measure.
- Ending Current Receivables: Typically, companies set the threshold for this at receivables that are outstanding for 60 days or fewer.
The Collection Effectiveness Index Formula
Now that you know its components, it’s time to put them together to form one formula:
(Beginning receivables + Monthly credit sales – Ending total receivables) /
(Beginning receivables + Monthly credit sales – Ending current receivables) x 100
For example, let’s say your business had $100,000 in receivables at the beginning of the year. You generated $1 million in credit sales over 12 months and closed the year with $120,000 in open receivables and $100,000 in current receivables.
Your calculation would look like this:
= ($100,000 + $1 million – $120,000) / ($100,000 + $1 million – $100,000) x 100
= (980,000 / 1,000,000) x 100
What To Know Before Using the CEI
Despite the CEI’s greater accuracy, the DSO is far more popular. There are a few good reasons for this. The DSO is much easier to calculate and uses fewer components. Consider the following factors as well:
- The CEI only works if you measure a year’s worth of data. Any shorter period will skew your results. If you don’t have complete data or are only interested in short-term results, the DSO may be a better option.
- You must have accurate records of all receivables, both at the beginning and end of the period, and credit sales made during that time. This can be difficult to track, especially if your business has many customers.
- The CEI is most useful for comparing the performance of your A/R team over time. However, it’s essential to remember that other factors can affect the CEI, such as changes in credit policy or the mix of credit sales to cash sales.
How A/R Automation Simplifies the Collection Effective Index
If you’re still using manual methods to track receivables, the CEI may seem like more trouble than it’s worth. Fortunately, there’s a better way. With accounts receivable automation, you can track receivables and credit sales and automate formula calculations. You can then add the CEI and other metrics to your centralized dashboard and convert data into reports that are easier to analyze.
These and other features free up your team’s time so that you can focus on more value-adding tasks. Book your Gaviti demo to see it in action.