The accounting and finance teams are predominantly working with numbers, hence there is loads of data and statistics that can be gathered. However, the abundance of data can lead to confusion too. What are the right metrics and data that really matters? Today we will guide you through the key metrics that will help improve your business’s Accounts Receivable.
Three Reasons to Monitor AR Metrics
Why starting to analyze your AR data is of major importance? First of all, AR directly impacts the cash flow of the business. Sometimes the sales can be growing, however, the cash flow problems may reduce the survival rates of many businesses. The cash flow problem is the major cause why SMEs fail.
Secondly, the power of numbers not only is capable of painting the health of your business processes but also gives your business a competitive advantage. Accenture has published a survey, where 79% of top executives believe businesses that do not embrace big data will lose market share and will face extinction.
Finally, we are living during uncertain times, therefore there are many external risks that your business may face. However, improving the internal factors like collections is entirely in the hands of your business. Bringing your AR in order is the crucial step towards securing your venture’s long-term success.
If you do not know where to start, do not worry, Kolleno has highlighted the key metrics that you have to monitor in order to improve your AR.
1. Days Sales Outstanding (DSO)
The DSO indicates how many days it takes for the business to collect its AR. To calculate the DSO you need to define a period, that is more appropriate for your type of business, it can be a month, a quarter, or a year. In the DSO formula you take the variables for the chosen period:
DSO= Accounts Receivables ÷ Net Credit Sales * Number of Days in a Period
The calculated metric tells you how many days it takes your business to get paid after the sales have been made. Intuitively, the shorter the period, the better, as you are not providing free credit to your clients. The potential cash locked up in your AR could be funneled for paying suppliers, staff, of your bills. So, be careful if this metric is going up. In order to understand what is a good DSO for your company, it is useful to look at the next metric.
2. Best Possible DSO
The Best Possible DSO is basically the goal you have to keep in mind. Ideally, your DSO should get as close to the Best Possible DSO as attainable. To calculate this metric, you have to consider only your current AR. This means that you look at your receivables that are not overdue and are within the payment deadline.
Best Possible DSO= Current Accounts Receivable ÷ Net Credit Sales * Number of Days in a Period
It is completely normal if the actual DSO and Best Possible DSO do not match. However, the too big of a gap may indicate that the collections are not as efficient, as they could be. Maybe the DSO could be decreased by sending your customers a timely reminder. If you are worried that your team will have to take on extra work by chasing customers, or they are not comfortable or nervous reminding the clients about the payment due date, you can simply automate this workload with Kolleno.
The Kolleno software extension is a complementary tool for your accounting software. Our cloud-based solution will not only identify the clients that are missing the payment but also will estimate the best timing for sending the reminder thanks to our machine-learning technology. Our clients have visibly improved their DSO without any effort.
3. Average Days Delinquent (ADD)
The ADD metric is useful for collection teams to track their success, or to identify the rising problems. To calculate the ADD you take the two previously calculate statistics:
ADD= DSO – Best Possible DSO
The gap between the Best Possible DSO and actual DSO can highlight that your collection teams may be struggling. You need to look at the bigger picture of why this can be happening. Is this because the sales are rising rapidly, is it due to low credit control, or simply due to the lack of staff to manage your AR?
Kolleno AR automation tool can solve the problem of understaffing, but also seamlessly communicate with any number of clients as necessary. The growth of sales won’t be detrimental to your cash flow, Kolleno will automatically communicate with clients via several communication channels but also prepare the branded invoices, after the sale has been made.
4. Accounts Receivable Turnover Ratio (ART)
ART = Net Annual Credit Sales ÷ Average Accounts Receivables
This ratio measures how many times per year your company is able to collect credit sales from your customers. This ratio is directly linked to your business’s cash flow, so it is important to track it regularly. The higher number the better, and it means that your customers are paying their bills on time.
5. Collection Effectiveness Index (CEI)
((Beginning AR + Monthly Credit Sales – Ending total AR) ÷ (Beginning AR + Monthly Credit Sales – Ending Current AR)) x 100
The CEI measures how much of your account receivables for a particular period were collected as a percentage of your total outstanding AR. If CEI is 100%, then your team has processed all AR in a month, however, it is very unlikely. The good CEI is around 80%, but it varies from industry to industry. You can calculate CEI monthly as it helps to see the dynamics of your collections’ efficiency. If your CEI decreases for no apparent cyclical reasons, try to audit your collections procedures.
Automating Your AR
While being on top of the above-mentioned AR metrics is key to improving the health of your cash flow, it sometimes can be too time-consuming. The good news is, that thanks to modern technology, it is easy and affordable to automate your AR. Moreover, it helps to save money too. According to the B2B Payments Innovation Readiness Playbook, 72% of firms that participated in the survey have reported savings on their operational costs thank to automating their AR. Do not hesitate and contact Kolleno to explore how seamlessly and efficiently we can help you improve your cash flow by automating your AR.