In this article, we will discuss the AR metrics that you must monitor to maintain a healthy cash flow and will help you approach Accounts Receivable management in the most efficient way.
September 19, 2022 
Accounts Receivable KPI show if the business is effectively collecting cash that is owed by its customers.
The AR KPIs can signal that the businesses need to adjust the current collection procedures and that the cash flow is suffering as a result of inefficient AR management.
The KPI such as days sales outstanding (DSO) shows how many days the cash is waiting to be collected after the sale has been successful.
The DSO is named the most important KPI monitored by businesses.
The Account Receivable software helps businesses to monitor the AR KPIs in real-time and set the collection strategies to improve cash flow without cutting expenditure.
Were you chasing that sale, did everything to close the deal with your potential client, which eventually ended up in success?
Now, after signing the contract or sending an invoice you are probably celebrating. However, a successful sale doesn’t mean the cash has arrived in your bank account. The cash that is not collected is sitting in your Accounts Receivable field of the balance sheet. How long can you wait for the cash to arrive, what amount of Accounts Receivable and what proportion is actually not a problem? What are actual Accounts Receivable KPI and what might indicate your cash flow is under pressure? In this article, we will discuss the AR metrics that you must monitor to maintain a healthy cash flow and will help you approach Accounts Receivable management in the most efficient way.
The majority of b2b payments are overdue. In the UK quarter of businesses encounter late payments on a regular basis. Moreover, some sectors such as manufacturing encounter up to one-third of late payments. However, how do you measure if your particular situation and Accounts Receivable management are nothing to worry about, or if there are some red flags?
To measure the AR performance it is vital to look at several KPIs for Accounts Receivable. The ratios are normally taking into account the volume of sales, the days it takes to get paid, and of course, the account receivable figure. In this article we look at five different AR KPIs that will help your business to measure its AR performance:
The most important goal of Accounts Receivable management is to ensure the cash that is paid for your business’s hard-earned sales is paid as quickly as possible. Even if the business does not experience cash flow problems, but has a large number of overdue invoices it makes it hard for the CFO to plan the future. Moreover, the overdue invoices are, essentially, a “free credit” to your customers, which you didn’t approve and they are having more cash at their disposal than you.
Therefore, for businesses with large Accounts Receivable outstanding it is problematic to commit to future investments, the unpredictable expenses can’t be met, and the employees might feel annoyed to keep reminding their customers to pay the invoices. Of course, it is very rare that b2b invoices are paid on time. In fact, Xero Research has identified that the percentage of overdue invoices for SMEs was 48%in Australia, 45% in New Zealand and 49% in the United Kingdom. So, there is no need to worry if your business encounters late payments. However, keep an eye on these AR metrics to find out if the overdue payments need a change in the AR management strategy.
The most important Accounts Receivable KPI is Days Sales Outstanding (DSO). The DSO shows how long on average your business is waiting to get paid after the sales have been recorded.
According to a survey by SSON, 56% of surveyed companies stated that DSO is their key AR metric. The reason for the popularity of using DSO as the indicator of Accounts Receivable is its relative ease of calculation and intuitive interpretation. For example, if the business has a DSO of 45 days, it means it takes on average 45 days for the cash to arrive in the bank account. The lower the DSO metric, the better. Also, this AR KPI is used by companies to show to their investors, to prove that they are the cash-generating business and have a good liquidity position.
Generally, the DSO of 45 days is considered normal. Some industries on average have higher DSO, for example, management companies have a DSO of 127, car rentals have an average DSO of 104 days, and engineering companies on average wait 74 days after the sale to get paid.
To calculate the Days Sales Outstanding you have to divide the Accounts Receivable by sales and multiply by 365 days.
For example, if the credit sales during the measured period (1 year) were 1,000,000 and at the end of the period the Accounts Receivable were equal to 200,000, the
DSO= 200,000/1,000,000*365= 73 days.
Average Days Delinquent (ADD) is also a KPI for Accounts Receivable that focuses on the days. However, in ADD AR metric the days are measured not after the sales have been recorded, but rather on the days after the invoice has become overdue. Every invoice has payment terms, also specifying the deadline until which the customer has to pay for the goods or services. Usually, the payment deadline is 30 days after the sale has been completed, but varies from one business to another.
Here is some vocabulary:
Overdue invoice: if the payment hasn’t been received and the payment deadline has passed, the invoice becomes overdue.
Current AR: all money that has not been collected from sales, but the payments deadline has not approached yet.
Accounts Receivable: This is total AR including the money earned from sales, but no cash received yet. It includes current and overdue invoices.
To calculate the Average Days Delinquent it is necessary to calculate the DSO first, and then the best possible DSO.
In the DSO formula, we have used the average Accounts Receivable. For the Best Possible DSO, we have to use the current Accounts Receivable.
ADD is simply the difference between the DSO and Best Possible DSO (BPDSO).
This AR KPI tells you about the adequacy of your collection processes. Usually, DSO and ADD are looked at together and should move in the same direction.
Monitoring the Accounts Receivable Turnover KPI is important as it tells how many times your business is collecting its average Accounts Receivable.
ART= Net Credit Sales / Average Accounts Receivable
For example, the credit sales of the business were $250,000. Accounts Receivable at the beginning of the year were $20,000 and it increased to $25,000 at the end of the year. The receivables turnover in this case is:
ART= $250,000/ ($25,000+$20,000)/2= 11.1 times.
The higher the Accounts Receivable Turnover, the better, as it means the company is collecting its AR frequently, rather than letting uncollected cash sit in the accounts receivable.
It also calculates the Account Receivable Turnover in days. For that AR KPI, you need to divide 365 by the AR turnover ratio. In our example the ART in days= 365/11.1= 32.9
This means that on average each customer pays 32 days after the sale has been performed.
The Collection Effectiveness Index is one of the key Accounts Receivable metrics that highlight how efficient your collection processes are. The high value of CEI says that the effectiveness is high and vice versa. The CEI is the third most popular Accounts Receivable KPI.
[(Beginning Accounts Receivable balance + credit sales) – ending balance of the Accounts Receivable)] / [(Beginning Accounts Receivable balance +credit sales)-ending current Accounts Receivable]*100
To understand the CEI and its utility as an Accounts Receivable KPI let’s examine this case:
Beginning Accounts Receivable: $250,000
Ending total Accounts Receivable balance: $90,000
Ending current AR balance: $18,000
Credit sales (monthly): $60,000
If we substitute these numbers, the CEI will be equal to 75%.
CEI= ($250,000+$60,000 – $90,000) / ($250,000+$60,000 – $18,000) * 100 = 75%
The interpretation of CEI is simple, as 100% means that your company collects all of the invoices. The lowest satisfactory CEI ratio is 80%. The one we have seen in the above example means that the collections can be improved and there is a need to examine the inefficiencies.
One of the most intuitive Accounts Receivable KPIs is the Average collection period. To calculate it, you have to divide the Accounts Receivable balance by yearly sales and then multiply by 365 days.
If sales during a year were $500,000 and the Accounts Receivables balance was $50,000, then the Average Collections Period for the business is calculated as follows:
$50,000/$500,000*365= 36 days, which is probably over the payment deadline if the standard payment terms were 30 days.
The shorter the average collection period the better. However, if the CEI is too low, then it probably indicates that the payment terms are too strict. In the long run, you might lose your customers to your competitors as their collections are more relaxed.
Effective accounts receivable management directly affects the cash flow of your business. Therefore, it is important to monitor the Accounts Receivable KPI in real-time and adjust your collection strategies based on the customer payment behaviour. While it might sound time-consuming and tricky to adjust the collections procedures continuously, there is no need to worry as the technology is already capable of automating mundane and complex tasks using AI algorithms. The AR automation software provides data insights and AR KPIs in real-time, thanks to the API connecting to your accounting software and powered with automatic payment reconciliation. Find out more about automation of credit control here.
