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Managing your accounts receivable (AR) efficiently is critical to maintaining healthy cash flow and ensuring long-term financial stability. To keep things on track, it's essential to regularly monitor accounts receivable KPIs—key performance indicators that give you critical insights into the health of your receivables. Tracking these KPIs helps you optimize collections, reduce overdue accounts, and improve your business's liquidity.
This blog will examine the top accounts receivable KPIs every business should monitor. We'll break down each KPI, explain its importance, and provide step-by-step examples of how to calculate it.
Before we get into the specifics, it's essential to understand what accounts receivable KPIs are and why they matter.
Accounts receivable KPIs are metrics that help businesses gauge how effectively they are managing their receivables. These indicators give you insights into the speed at which payments are collected, how streamlined your invoicing process is, and the overall health of your company's cash flow. Monitoring these KPIs is vital for evaluating your company's financial performance related to its receivables.
By closely monitoring these KPIs, you can spot bottlenecks in your collections process and take proactive steps to fix them. This allows you to improve liquidity, reduce the risk of bad debts, and ensure working capital is available when needed.
Cash flow is the lifeblood of any business, and your accounts receivable process plays a huge role in maintaining it. Regularly monitoring your accounts receivable KPIs provides a clearer picture of your company's cash flow, helping you make smarter financial decisions and avoid liquidity problems.
Tracking accounts receivable KPIs doesn't just optimize collections—it ties directly into broader business goals. Better KPIs can reduce borrowing costs, enhance vendor relationships, and position your company more strongly in the market.
Contact us to learn how our accounts receivable management solutions can help streamline your processes and improve cash flow.
In this section, we will understand what Days Sales Outstanding is and look into its definition.
Days Sales Outstanding (DSO) measures the average number of days it takes a company to collect payment after making a sale. This is one of the most critical accounts receivable KPIs because it directly affects cash flow.
A higher DSO might indicate that your collections process is inefficient, whereas a lower DSO suggests you're collecting payments promptly.
DSO = (Accounts Receivable ÷ Total Credit Sales) × Number of Days
Your business has $100,000 in accounts receivable and $300,000 in total credit sales over 30 days. Using the DSO formula:
DSO = ($100,000 ÷ $300,000) × 30
DSO = 0.33 × 30
DSO = 10 days
In this case, collecting payment takes an average of 10 days.
Lowering your DSO means you're converting sales into cash faster, which helps improve your liquidity. Keeping DSO as low as possible is crucial for maintaining a healthy cash flow and avoiding late payments.
Also read- Understanding How to Calculate Debt Service Coverage Ratio (DSCR)
Let's look at another important KPI: Average Days Delinquent (ADD).
Average Days Delinquent (ADD) measures the average number of late payments beyond the expected due date. It's a valuable KPI for assessing the effectiveness of your collection processes and identifying potential risks, such as future bad debts.
ADD = DSO – Best Possible DSO
Assume your company's DSO is 45 days, and your best possible DSO (i.e., the average collection time under ideal conditions) is 30 days. The ADD calculation is as follows:
ADD = 45 days – 30 days
ADD = 15 days
This means payments are, on average, 15 days late.
A high ADD signals poor collections performance and an increased risk of bad debts. By monitoring ADD, you can pinpoint issues and take action to mitigate these risks—whether by refining your collections process or adjusting credit terms for high-risk customers.
The Accounts Receivable Turnover Ratio (ART) indicates how often your business collects its average accounts receivable during a specific period. It's a valuable metric for evaluating the efficiency of your collections and the health of your receivables.
ART = Net Credit Sales ÷ Average Accounts Receivable
Your net credit sales for the year are $1,000,000, and your average accounts receivable balance is $200,000. The ART calculation is:
ART = $1,000,000 ÷ $200,000
ART = 5
This means your company collects its average receivables five times a year.
A higher ART indicates that your company efficiently collects receivables, which is great for cash flow. A lower ART, however, suggests inefficiencies in collections that may require attention.
Next, we'll discuss the Collection Effectiveness Index (CEI) and how it reflects the overall performance of your collections strategy.
The Collection Effectiveness Index (CEI) gauges the overall effectiveness of your collections strategy over a specific period. It clearly shows how well your team collects outstanding payments compared to the amount due.
CEI = [(Beginning AR Balance + Credit Sales During Period) – Ending Total AR Balance] ÷ [(Beginning AR Balance + Credit Sales During Period) – Ending Current AR Balance] × 100
Imagine your beginning AR balance is $150,000, credit sales during the period total $500,000, your ending total AR balance is $100,000, and your current AR balance is $75,000. Using the CEI formula:
CEI = [($150,000 + $500,000) – $100,000] ÷ [($150,000 + $500,000) – $75,000] × 100
CEI = $550,000 ÷ $575,000 × 100
CEI = 95.65%
A CEI of 95.65% means you're recovering almost 96% of what's owed, a strong indicator of an effective collections strategy.
CEI provides a comprehensive view of how well your collections efforts are working. A high CEI indicates that your strategy is sound. At the same time, a lower CEI suggests you need to make adjustments, such as increasing follow-up efforts.
The bad Debt-to-Sales Ratio measures the percentage of total sales that turn into bad debt, helping you assess the effectiveness of your credit policies. If this ratio is too high, it may signal that your company is extending credit to customers who are unlikely to pay.
Bad Debt to Sales Ratio = (Bad Debt ÷ Total Sales) × 100
If your business incurs $50,000 in bad debt and generates $1,000,000 in total sales, the calculation would be:
Bad Debt to Sales Ratio = ($50,000 ÷ $1,000,000) × 100
Bad Debt to Sales Ratio = 5%
This means that 5% of your total sales resulted in bad debt.
Monitoring this ratio allows you to evaluate whether your credit policies need tightening. A high bad debt-to-sales ratio may indicate that stricter credit checks or revised payment terms are required.
Also read- Actions Against Debt Collectors for False Statements and Violations
This KPI tracks how often your company revises invoices due to errors, incorrect information, or customer disputes. Frequent revisions can delay payments and hurt customer relationships.
Monitoring the number of revised invoices helps you identify patterns in billing errors and reduce their occurrence. Improving your invoicing accuracy leads to quicker payments and better customer relationships.
Effectively managing accounts receivable means closely monitoring key performance indicators (KPIs). Tracking KPIs such as DSO, ADD, ART, and CEI gives you valuable insights into how efficiently you're collecting payments, reducing bad debts, and managing cash flow.
By linking these KPIs to your collections strategy and leveraging automation tools, you can ensure that your receivables are collected promptly and with fewer errors. In today's fast-paced business world, using AR metrics to drive improvements is essential for maintaining financial health.
Ready to optimize your accounts receivable process? Let our team help you implement tracking and reporting systems that drive better collections performance and keep your business financially secure.
