“Must Have” Metrics for Receivables Management
Intelligent Credit & Collection Oversight is the Goal
Monitoring and tracking cash is a critically important activity for most small businesses (for more on that subject, check out “Taking the Crystal Ball out of Cash Flow Forecasting”). Since payment of Accounts Receivables (AR) is the primary source of regular cash inflows for most companies, you need to also track your AR to not only maintain its health as well as to better manage it and ensure maximum cash inflow.
The alternative . . . running short of cash can be a disaster! The consequences of not being able to meet payroll, tax, employee health insurance, rent, lease and key supplier payments can seriously impair your firm’s operations, both immediately and well into the future.
One of the biggest challenges for small business executives is finding enough time, so it’s important to efficiently monitor your cash position to avoid disruptive events. The objective involves minimizing the time and effort expended in tracking and reporting on your AR, while optimizing this assets contribution to working capital.
Your accounting software or ERP solution should facilitate the tracking of your AR and thereby save you lots of time. If nothing else, your software should provide an AR Ledger, which is simply a comprehensive listing by customer of every open invoice they owe. Even if your accounting solution isn’t robust, it should allow you to export your AR details into a spreadsheet that can then be used to create the needed reports and metrics. A word of caution: while spreadsheets are a useful tool for tracking issues your accounting solution doesn’t cover, if you bccome reliant on too many spreadsheets to manage your business, you probably should be shopping for more inclusive and powerful software.
Why Are Metrics Needed if You Have an AR Ledger?
Metrics enable you to quickly check the condition of your AR (and cash inflow for the immediate future). If conditions are satisfactory and all your credit and collection assignments have been completed, you can then address the many other tasks and challenges requiring your attention. Unfortunately, this is seldom the case, and by itself the AR Ledger provides very little in context for determining how your receivables are trending.
If there is room for improving the condition of your AR, the typical state of affairs, AR metrics will indicate which element or dimension of the AR is a problem, the magnitude of the problem, and where to direct your attention. For a small business, metrics should not be designed to provide great detail, but rather to display the overall health of the asset (which is one of the largest for most companies), and an indication of where improvement is needed. As such, the AR metrics you track should be arrayed in a brief, easy to review reporting format.
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Essential Cash Flow and AR Metrics and Reporting Frequency
What we are prescribing below will require a very minimal amount of your time on a daily basis, just marginally more time on a weekly basis, and still just a modest amount of time on a monthly basis, assuming you keep up with your daily and weekly reporting. Here’s the plan:
Daily:
Cash receipts and cash balance(s) in your bank(s). This is readily available from your daily bank deposit(s) and by looking up the cash balance in your depository account(s) at your bank(s). It is a good idea to record these items on a daily log along with outflows.
Weekly:
Cash receipts for the week and cash balances at end of the week. Simply make room on your daily log for weekly totals.
Total AR from your AR Ledger. This will show you weekly fluctuations in your AR balance, and over time provide you with insights into any cyclical or long term patterns.
Past Due AR Balances. Most account software will allow you to print an Aged Receivables Trial Balance (ARTB) that contains aging buckets for each open account. An ARTB is simply a more detailed version of the AR Ledger. Usually the aging buckets are configurable, but if not the typical output has columns for Total AR, Current, Past Due 1-30, PD 31-60, PD 61-90, and PD over 90. The key totals to watch on a weekly basis are PD over 30 (everything that is not current or only 1-30 days past due) and PD over 90. It’s also very beneficial to track for comparison’s sake the percent of total AR each bucket represents. These metrics highlight the amount of AR that should have already been paid and is becoming less collectible every day — be aware, the over 90 day past due AR is in imminent danger of not being paid. Many people only run the ARTB once or twice a month, but then you are likely to let past due receivables slide out further before corrective actions can be taken, so be on the lookout for large balances rolling from one aging bucket to another and take appropriate action. Also, you don’t need to print the whole report every week - most accounting software will allow you to print just a summary page.
Monthly:
The Three Weekly Metrics listed above
Days Sales Outstanding (DSO) – This metric expresses the level of AR as the number of days of sales that comprise your AR total. It is a measure of AR turnover. For example, if you sell on Net 30 day credit terms, and all your invoices were paid on the due date, your DSO would be 30 days. In the real world, with customers making late payments, your DSO will be higher than your stated credit terms. If actual DSO is 15-20% higher than your credit terms, you’re in good shape. If it is 100% higher, then you have a serious cash flow problem and face potential bad debt losses because your customers are abusing the credit terms you have extended to them. It is also advisable to plot DSO against monthly sales and the end of month AR balance so you can see what is driving changes in your DSO. For example, rising sales will tend to increase DSO even when collections remain on par. There are different formulas for computing DSO that account for the complexities that arise, so if you’d like guidance on how to compute it, just contact us – we’ll be happy to advise. The most common formula used is:
DSO = (AR Balance/Total Credit Sales) X Days in Period
Collection Efficiency Index (CEI) - As mentioned above, DSO is skewed by what is going on in sales. The CEI is a good complement to DSO because it factors out sales to just measure the percentage of receivables a company has collected during a defined period. A high CEI (approaching 100 percent or above) indicates that your credit and collections efforts are effective. If your CEI is only running around 90 percent month-to-month, your are rapidly loosing ground and your collections process needs attention.
Unapplied Cash – this is a “housekeeping” metric. Unapplied cash consists of customer payments that have not been applied to open invoices. It is caused from missing or unclear remittance advice (i.e., instructions from the customer as to which open invoices they are paying). These payments can usually be applied by contacting the customer for clarification of the payment details. The danger with unapplied cash is that customer invoices will appear open (unpaid) when in fact, they have been paid. Unnecessary collection contacts will be made, which annoys customers and wastes your time. Worse, you may hold an order pending payment of an apparent unpaid invoice. It’s important that the level of unapplied cash not exceed 2 to 3 percent of total AR, in order to ensure unnecessary collection contact and order holds are kept to an absolute minimum.
Disputed AR – hopefully, this is generated by your AR Ledger system or a separate Dispute/Complaint/Issues log. In most accounting systems, there is a field that can be used to identify that an invoice is being disputed. Otherwise, all disputes should be logged in a spreadsheet that tracks the customer, invoice/item number, amount, and status (open/closed). Amounts in dispute are in serious jeopardy of:
Being paid late (a virtual certainty)
Never being paid
Being paid for a less than the invoice amount.
Even worse, the collectability of disputes decreases rapidly over time. You must have visibility to the magnitude and age of disputed invoices to avoid a potentially large loss.
In the Final Analysis…
Tracking and then reporting metrics takes time and effort. However, the absence of basic tracking and reporting can lead to large revenue losses and decreased cash flow. The good news is that most modern accounting software contains reporting tools that, once configured properly, will do most of the work for you. The best solutions provide dashboards that help keep important metrics front and center.
With the handful of critical metrics highlighted above, you can avoid being blindsided by cash and revenue issues that can cripple your company. A modest amount of effort, often concentrated in the setting up your reporting parameters, can help you avoid huge problems.
If you need help choosing an inexpensive solution for managing, tracking, and reporting on your AR asset, one of our associates at YVCM will be glad to assist you.