Effective management of accounts receivable is crucial for maintaining a robust cash flow and optimizing working capital in the field of finance. To monitor and enhance the performance of accounts receivable, finance teams rely on key performance indicators (KPIs) as essential tools.
In this article, we will explore the top KPIs that every accounts receivable finance team should be familiar with. These KPIs, accompanied by their respective calculation formulas, enable finance teams to track progress, identify areas for improvement, and drive financial success.
Days Sales Outstanding (DSO)
DSO represents the average number of days it takes for a company to collect payment after a sale has been made. It is a key measure of the effectiveness of an AR department and can be calculated using the following formula:
DSO = (Total Accounts Receivable / Total Credit Sales) x Number of Days
A lower DSO signifies that the company collects receivables more quickly, indicating efficient credit and collection processes.
Average Days Delinquent (ADD)
ADD provides a snapshot of how long, on average, invoices go unpaid past their due date. It offers a perspective on the timeliness of payments. The formula for ADD is:
ADD = (Total Overdue Receivables / Total Invoices Outstanding) x Number of Days
The lower the ADD, the better, as it implies that payments are being made closer to their due dates.
Collections Effectiveness Index (CEI)
The CEI is a measure of the ability of the collections department to collect funds from customers. It is calculated as follows:
CEI = [(Beginning Receivables + Monthly Credit Sales - Ending Total Receivables) / (Beginning Receivables + Monthly Credit Sales - Ending Current Receivables)] x 100
A higher CEI percentage indicates a more effective collections process.
Accounts Receivable Turnover (ART)
ART ratio demonstrates how efficiently a company uses and manages the credit it extends to customers and how quickly that short-term debt is collected. Its formula is:
ART = Net Credit Sales / Average Accounts Receivable
A high ART indicates that the company collects its receivables more frequently within the period.
Bad Debt to Sales
This KPI measures the percentage of receivables that cannot be collected. It is calculated as:
Bad Debt to Sales = (Bad Debt / Total Credit Sales) x 100
A lower ratio is preferable as it signifies a low level of uncollectable debt relative to sales.
Collection costs reflect the efficiency of the collection process. Lower costs imply better efficiency. To calculate it:
Collection Costs = Total Collection Expenses / Total Collections
Right Party Contact (RPC) Rate
The RPC rate measures the effectiveness of the collections team in reaching the correct party. It is computed as:
RPC Rate = (Number of Successful Right Party Contacts / Total Number of Attempts) x 100
A higher RPC rate indicates more successful collection efforts.
Number of Revised Invoices
This KPI measures the accuracy of the billing process. A lower number of revised invoices indicates better accuracy and less confusion for customers.
Number of Revised Invoices = Total Number of Invoices Sent – Total Number of Correct Invoices Sent
In conclusion, these KPIs form the backbone of an effective AR monitoring system. They allow for the quick detection of performance gaps, timely intervention, and efficient decision-making.
By thoroughly understanding and regularly tracking these KPIs, AR teams can significantly enhance their performance, improve cash flow, and contribute to the overall financial health of their organization.
As with all metrics, these KPIs should be viewed in the context of the company’s specific industry, size, and historical trends to make meaningful comparisons and drive meaningful improvements.