Top 5 Accounts Receivable KPIs to Monitor

Introduction

Key Performance Indicators (KPIs) are diagnostic tools used to measure performance in many fields, such as finance, marketing, and operations. KPIs serve as an important way for companies to monitor and measure their success over both the short-term and long-term. By making data-driven decisions, organizations can optimize how effectively their resources are allocated and identify areas for improvement.

Accounts receivable KPIs specifically measure performance within the accounts receivable department, which is responsible for managing invoices, tracking payments, and ensuring the timely collection of receivables. Organizations use accounts receivable KPIs to gauge the effectiveness of their collection process, ensure timely payments, and understand the financial health of their customers.

2. Day’s Sales Outstanding (DSO)

Day’s Sales Outstanding (DSO) is an important metric that your business needs to pay attention to if you want to track and manage your accounts receivable effectively. It is a measurement of how long it takes the company to collect its payments from the customers. By monitoring your DSO, you can gain better insights into your customers’ payment behaviors and become better equipped to handle any problems that may arise.

A. Overview

DSO is a key performance indicator (KPI) used by many companies to monitor their accounts receivable. It indicates how long it takes to collect money from customers, based on the average time it takes from when goods or services are sold to the time when payments are received. It is a simple yet important metric that helps you predict cash flow and measure the efficiency of your customers’ payment processes. By tracking DSO, you can identify potential problems before they develop into major issues.

B. Benefits of tracking

Monitoring DSO provides you with numerous benefits, such as:

• Provides insight on customer payment behaviors
• Helps you identify any potential payment problems
• Provides a better understanding of your current level of cash flow
• Makes it easier to detect any payment discrepancies between customers
• Enables you to better manage customer relationships

C. How to calculate

The calculation of DSO is relatively simple: it is simply the total number of days of outstanding invoices, divided by the number of days in the period. The formula is as follows:

DSO ⁄ (Total AR for the period ÷ Total Sales for the period) x Number of days in the period

For example, if your total accounts receivable for a particular period is $10,000, and you have made sales of $20,000, then your DSO will be 5 days (10,000 ÷ 20,000 x 5 days).

Gross Debt Ratio

The Gross Debt Ratio – sometimes referred to as the receivables collection ratio – is the ratio of your total receivables to your total sales. This KPI gives an indication of how well you are collecting payments from your customers and how quickly you are doing so.

Overview

The Gross Debt Ratio provides you with insights into the efficiency of your receivables collection process. A low ratio suggests that your customers are paying quickly, while a high ratio suggests that your customers are taking longer to pay. The Gross Debt Ratio is a simple credit KPI that can identify potential issues with customer payment behaviour, allowing you to take proactive steps to ensure payments are collected on time.

Key Metrics

• Total Receivables: The total value of all invoices issued and outstanding.
• Total Sales: The total value of all sales made.
• Gross Debt Ratio: The ratio of Total Receivables to Total Sales.

How to Interpret

A higher Gross Debt Ratio is typically a sign of an inefficient customer payment process. If your ratio is high, it’s likely that your customers are taking longer to make payments. You should look into the cause of the delay and take steps to ensure payment terms are being met. A lower ratio suggests that customers are paying quickly and that your payment process is efficient.

4. Bad Debt Ratio

Bad debt ratio is an important measure of a company's ability to collect on outstanding accounts. It is calculated as a percentage of total expected payments for a given period compared to the total amount of outstanding accounts receivable. The higher the percentage, the more of the receivables may not be collected.

A. Overview

The bad debt ratio measures the account receivable that is not expected to be collected. This is a measure of a company's credit policies and effectiveness in collections. This ratio is most useful when trends can be identified. Understanding this measure can help managers make informed and proactive decisions to manage their accounts receivable.

B. Benefits of Monitoring

Monitoring the bad debt ratio is important because it indicates how well a company is managing its receivables. If this number is too high, it may signal that a business has not been able to successfully collect payment from customers. This can alert managers to potential issues and help them make decisions to reduce the amount of bad debt.

Monitoring this ratio over a period of time can also reveal underlying trends. If the ratio is increasing, it could signal that collections policies need to be tightened or that credit terms may need to be adjusted. Identifying these trends can help improve receivables management.

C. How to Interpret

The bad debt ratio should be compared to the amount of overall receivables for the period to determine if the ratio is acceptable. This will help managers determine if the amount of bad debt is increasing or decreasing. If the ratio is too high, it may indicate that further attention is needed in the collections process.

Another way to interpret this ratio is to compare it to similar companies or industry averages. This will give managers a better idea of how their business is performing when compared to others. If their bad debt ratio is higher than average, it could alert them to potential issues.

Average Collection Period (ACP)

The Average Collection Period (ACP) is one of the key performance indicators (KPIs) used to measure how efficiently accounts receivable payment collections are being processed. It is a measure of the average length of time a company takes to collect payments after invoicing its customers. Knowing this figure can help businesses analyze the effectiveness of the credit policies in place and the overall accounts receivable management process.

Overview

The ACP formula is derived by dividing the amount of money outstanding, or receivables, by the total amount of credit sales in the same period and multiplying it by the number of days in that period.

Benefits of tracking

Tracking the Average Collection Period for your accounts receivable is important for understanding when and how quickly you can expect to be paid. It also helps in developing more accurate cash flow forecasts and improved income statement projections. By analyzing this KPI, businesses can identify areas where they need to improve their collection processes, such as reducing the number of days it takes to collect payment, shortening credit terms, or enhancing their collections management strategies.

How to Calculate

Calculating the Average Collection Period requires the following information:

• Accounts Receivable Balance during a given period
• Total Credit Sales during that period
• The number of days in that period

The ACP formula is then: ACP = Accounts Receivable ÷ Total Credit Sales in the period X Number of Days in the period.

6. Uncollectible Accounts Receivable

Uncollectible accounts receivable is an important metric that allows you to quickly identify the status of the customer debts. It is an essential measure of a company’s overall financial health and helps to ensure that it remains in a strong financial position.

A. Overview

Uncollectible accounts receivable (AR) is money that a business has to write-off when a customer or a debtor fails to pay their debt. It is also known as a “bad debt” and it is reported as an expense in the company’s balance sheet. Bad debt reflects the possible loss of money that a company may experience due to a bad debt.

B. Benefits of Monitoring

Monitoring uncollectible accounts receivable KPI provides an effective way to identify and pursue unlucky customers who cannot pay their debt and establishing effective accounts receivable management.

• It provides early visibility of the outstanding amount of a customer and helps to ensure that collection efforts can be made in time.
• It will help to understand the overall financial position of the company.
• It allows the company to take necessary actions to reduce bad debts.

C. Using The Five Write-off Method

The Five Write-off Method is one of the most popular methods used to calculate uncollectible accounts receivable. This method allows organizations to consider all debtors’ actions and assess the bad debt amount accurately.

• The organization must assess the debtors’ payment trend and identify which ones reach the overdue duration or payment deadline.
• Then the organization needs to assess the debtors’ resolve to pay their debt and decide whether to pursue the collection effort.
• In the case of a debtor who has no intention to pay their debt, the organization can proceed with the five write-off method.
• The five write-off method starts from a minimum level of write-off and gradually increases the percentage of write-off until the debt is written off completely.

Conclusion

Accounts receivable KPIs are essential for understanding the financial health of a company. The top 5 KPIs to monitor are days sales outstanding, gross collection rate, accounts receivable aging, percentage of sales on credit, and percentage of sales collection in terms of payment window. Monitoring these KPIs help companies to understand the working capital cycle, forecast and budget correctly, identify overdue invoices quickly, ensure timely payments are received, improve customer relationships and enhance cash flow management.

Tracking and monitoring of accounts receivable KPIs offers numerous benefits to a business. It helps to improve financial operations by making sure that all receivables are collected on time. It also helps to identify any potential problems in the accounts receivable process before they become unmanageable, thereby eliminating the need for costly solutions. Furthermore, it allows businesses to better gauge the performance of their accounts receivable department and make necessary adjustments to ensure that receivables are collected in a timely manner.

By carefully tracking and monitoring the accounts receivable KPIs, companies can maximize their cash flow, improve customer relationships and ensure that their accounts are managed properly. This helps to enhance overall profitability and financial health, while reducing the risks associated with unpaid receivables.