In a recent blog post, we discussed Days Sales Outstanding (DSO) and its impact beyond the finance department. We also shared how DSO, while offering valuable insight into accounts receivable (AR) performance, isn’t the best metric for measuring collector effectiveness. In this post we’ll discuss another metric used by finance professionals, that when coupled with DSO, tells a more holistic credit and collections story.
Defining Collection Effectiveness Index
The Collection Effectiveness Index, or CEI, is a calculation of a company's ability to retrieve their AR from their customers. In other words, CEI compares the amount that was collected in a given time period to the amount of receivables that were available for collection. A CEI near 80% or above indicates a highly effective collections process, while a CEI of around 50% and below is considered low and should be further evaluated. Why does tracking CEI matter though? More or less, this metric can directly show you the speed it takes to convert A/R to a closed out, paid account.
Let’s take a look at an example to further explain how DSO and CEI are different. Two companies could have the same DSO, but the state of their collections risk could differ. A business can have a percentage of their receivables in newly or recently passed due buckets and a percentage of their receivables in higher aging buckets including 90+ days. The breakdown of those receivables and what aging buckets they’re in then determines the likelihood that they’ll be able to collect and ultimately get paid.
Breaking Down CEI
Now that we’ve explained what CEI is, let’s go through an example of how to calculate. First, let’s define some terms we’ll use to explain the formula beforehand.
- Beginning receivables is a company’s open receivables at the start of the month. It’s also the ending total receivables for an organization from the previous month. For example, if a business had an ending total receivables of $30 million on February 28th, the beginning receivables for March 1st would also be $30 million.
- Monthly credit sales is how much money is made via sales in that month.
- Ending total receivables is all of the open receivables including current and overdue receivables.
- Ending current receivables are strictly the open receivables that are not overdue.
With those terms now in context, below is the formula that you would use to calculate CEI for your company.
Let’s look at an example with real numbers below.
CEI nirvana would be as close to 100% as possible. Although, a more realistic CEI of 80% or 90%, would also be preferable compared to a score like 50%.
Another thing to note about CEI is that it takes into account the weight of your invoices. To better explain this, assume a business had two overdue invoices, one for $100 that was one day overdue and the other was $1,000,000 that was 45 days overdue. It wouldn’t be completely accurate to say that the average for the overdue invoices was 23 days. This is simply because their age and amount are drastically different.
Making ROI Tangible
Companies are always going to be focused on ROI and for good reason. Yet for a collections analyst, the faster they can get an invoice paid in full, the quicker their company can realize their cash flow and impact top-line revenue. While metrics like DSO and CEI help tell part of the collections story on their own, together they are more impactful and help share a full financial view.
Want to learn more about DSO and CEI and what they can tell you about your business? Reach out to [email protected].