Here's a question for you –
Do you regularly track your progress when trying to achieve a specific goal?
Now, you may have a question for us, what is the importance of tracking the progress regularly?
Well folks, “By tracking progress, we get the most accurate picture of our goals when we’re measuring them with the appropriate units.”
Similarly, in the world of Accounts Receivable, you need to track key metrics to ensure sufficient cash flow and keep the business's financial health in check.
If you didn't track your follow-up actions or any key performance metrics in your accounts receivable process, it would be difficult to audit an accurate report.
Isn’t it Right?
Sometimes, you can't sue the customer for keeping payment dues, just because you didn't track the evidence of the escalation. If you do so, well get ready to lose a valuable asset(customer) of your business.
As your business goals change over time, so will the most relevant financial KPIs (key performance indicators) for your company. To focus on the metrics that matter, pay attention to those that bring performance into focus. Confused about which metrics to track?
That's why I'm here to show you the top 5 accounts receivable metrics you should track for your business.
Days Sales Outstanding (DSO) is a widely used statistic in accounts receivable management. It is an essential indication of how well a company collects money from its customers. DSO is computed by dividing total receivables by average daily sales.
Accounts receivable refers to the entire amount of money owing to an organization by customers, while total credit sales relate to the total amount of credit sales completed within a certain time. The term is generally either a month or a quarter in length.
DSO is an essential indicator since it informs organizations about how long it takes to collect payments from customers on average. A high DSO indicates that a company is taking a long time to collect payments, which can harm cash flow and working capital. A low DSO, on the other hand, suggests that a company is receiving payments fast, which is a good indicator of cash flow and financial stability.
To improve DSO, businesses can take several steps, such as:
Streamline invoicing and payment processes: You can improve your invoicing and payment processes to make it easier for customers to pay their invoices on time. Offering online payment options or sending payment reminders are examples of this.
Set explicit payment terms with customers: You can set clear payment terms with your customers, such as requesting payment within 30 days after invoicing. This can assist guarantee that customers pay on time and lower the risk of late payments.
Accounts receivable should be closely monitored: You should closely monitor your accounts receivable to discover any late payments and take measures to recover them as soon as possible.
Discounts for early payment: You can give discounts to your customers who pay their invoices on time, encouraging prompt payment and lowering DSO.
Overall, DSO is an important indicator in the accounts receivable management system that may assist organizations in understanding how effectively they collect payments from customers. You may enhance their cash flow and financial stability by adopting initiatives to improve DSO.
Understanding the average collection time for accounts receivables is essential in tracking the financial progress. Almost every financial reporting system monitors this metric as part of the baseline performance metrics. By looking at when DSO rises or falls, you can also learn how market forces affect payment times.
APQC conducted a bench-marking survey and found that top-performing companies have a DSO of less than 30 days, whereas low-performing companies have a DSO of 48 days or more.
The Best Possible DSO only considers accounts receivables that are current, not those from the past. The results indicate how long it will take to receive your payments on time.
DSO should tend toward a target DSO (where one has been set) or the BP-DSO value (unless seasonal volatility can get in the way). It is not realistic to set a target DSO equal to the BP-DSO unless the company has a very small number of bad-paying customers.
The Collection Effectiveness Index measures how well you can collect your due payments from customers within a given timeframe, usually monthly, though you can track it over any timeframe.
In general, a flawless collection effort would result in a percentage of 100%. However, 80% or better would be a good percentage. As opposed to Days Sales Outstanding [DSO], the Collection Effectiveness Index focuses on the number of invoices outstanding and measures your company's ability to collect total payments due.
In some cases, Accounts Receivable metrics can be compared with competitors so you can see how fast your company collects payments compared to the industry's average. The collection Effectiveness Index isn't used for bench-marking against peers, but rather as an internal measure of accounts receivable teams' performance.
Overdue payments are measured by the Average Days Delinquent metric. By encouraging clients to pay quickly, you need to lower this number as much as possible. If the number is high, it may indicate problems with the accounts receivable, or within the company itself.
A long-overdue payment could also mean that you are targeting the wrong customers, or you might not have enough resources.
The turnover ratio is a financial indicator that indicates how well a company manages its receivables. It is also known as the accounts receivable turnover ratio and is calculated by dividing total credit sales by average accounts receivable over a certain period. The ratio gives important information about a company's cash flow and stability, as well as its capacity to recover existing debts.
In an accounts receivable process, the turnover ratio is a measure of how many times your company's receivables are collected and replaced in a certain period, generally a year. This ratio is calculated by dividing total credit sales by the period's average accounts receivable balance. The resultant value indicates how successfully you manage your company’s accounts receivable and how soon those receivables are converted into cash.
Credit sales are the total amount of credit sales made throughout the period. The average accounts receivable amount is calculated by adding up the starting and ending balances of the period and dividing them by two. This aids in smoothing out seasonal swings in the accounts receivable balance.
For example, if a company had $1,000,000 in credit sales and a $250,000 average accounts receivable balance over time, its turnover ratio would be:
Turnover of Accounts Receivable = $1,000,000 / $250,000 = 4
This indicates that over the period, the company collected its whole accounts receivable balance four times.
A high turnover ratio is often regarded as a favorable indicator, indicating that a firm is collecting receivables promptly and effectively. This can help to enhance cash flow and lower the risk of bad debts. A low turnover ratio, on the other hand, indicates that a firm is having difficulty collecting receivables, which can lead to cash flow issues and an increased risk of bad debts.
In conclusion, the turnover ratio in your accounts receivable process is an essential metric that indicates how well your organization manages its receivables. You can enhance your overall financial health by monitoring this ratio and identifying opportunities for improvement in your accounts receivable management systems.
Tracking all these KPIs can get overwhelming and tedious for you, right? What if there was an easy way out?
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