What is the cost of collecting $1000 revenue?

An analysis of how the cost of collecting per $1000 revenue changes with invoice age

Converting credit sales deals into real cash is not always easy, and often involves hefty $$ costs! 

Overdue invoices can be up to 400% -900% more costly to collect than those within the credit period.

Let's take a deep dive into how the cost of collections changes as the invoice ages.

What’s the cost of collecting $1000?

On average, a company that earns $100 million in revenue (from 100,000 invoices) spends ~69 cents to collect one thousand dollars. (All assumptions are mentioned at the end of the article) 

Here the $1000 is spread across different aging buckets. Some portion of the $1000 revenue would be within the credit period, while some of it may be past the due date by 30 days, 60 days, or 90 days. (Please check at the end of the article for the proportions)

We dived further to see how the costs of collections change as a $1000 invoice moves through the different aging buckets. The collection costs comprise of:

• Labor costs: This covers the salary of the collector(s)
• Communication/dunning charges: This includes the cost of phone calls, emails, etc. to remind the customers about their invoice dues.
• Weighted Average Cost of Capital (WACC) expenses: This represents the additional cost that the business has to incur to borrow capital from other sources due to the delayed cash flow.

Within the credit period: The cost of collecting $1000 is the lowest when it is within the credit period, approximately 15 cents – 20 cents. During this period, labor charges constitute almost the entire collection costs (assuming email communication costs are nil).

0-30 days: This is the first aging bucket. The invoice is past due now. The collections team makes at least one phone call to the customer regarding the delayed payment, in addition to sending email reminders. With the payment delayed, the business also needs to arrange capital from external sources for its operations. Together, these increase the cost of collecting $1000 revenue in this bucket to $1 – $2.

31-60 days: Once the invoice moves into this bucket, the cost of collections increases by almost 200%. It takes $4 – $6 to collect $1000 in revenue stuck in this bucket. This increase is primarily driven by an 80% rise in total WACC costs as you now need to borrow capital for two months as against one month in the previous bucket. Dunning charges also increase by 20% as collectors place more phone calls (at least two) to follow up rigorously with the client.

61-90 days: This is often the last bucket before which most businesses write off the invoice amount. Collecting $1000 from this bucket can cost $7 – $9. WACC costs increase by 67% compared to the previous aging bucket, considering the higher charges you need to pay for the capital borrowed for a longer time (three months in this case). As for the previous bucket, collectors place at least two phone calls to the client regarding the delayed payment.

> 90 days: The cost of collecting $1000 now touches $9 – $12. The chance of collecting an invoice that is 90 days past its due date is very low. While collectors reduce the time and effort they put in to collect the invoice, WACC costs remain high due to the continued reliance on borrowed capital. 

At this point, businesses may also sell these invoices to third-party debt collection agencies to recover the money. Collection agencies either charge $10 – $15 per account or 10% – 50% of the amount collected, depending on the invoice age and value.

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How can you minimize collection costs?

Financial consultants advise collecting invoices on time to avoid the increase in collection costs and minimize working capital expenses.

Here are a few tips to help you collect payments at the lowest cost.

• Segment and prioritize customers: Prioritize risky accounts that owe you larger amounts. If your team is spending time and effort on low-value or less risky accounts, then the return on your collection efforts is lower. Segment between high and low-dollar value invoices and prioritize accounts/invoices that form a significant percentage of your total unpaid invoice value.
• Customer self-service tools: A study by APQC finds that businesses that offer customers self-service tools for payments and dispute resolution have significantly lower collection costs. Customer self-service tools help lower the costs of communication as the tool sends notifications as well as helps customers organize and track invoices easily.
• Regular customer communication: Regularly communicate with your clients before invoices become overdue. Send automatic reminders during set times before and after the invoice due date. One of the common reasons for missing payments is forgetting the payment deadlines, and this can be resolved through regular communication with the customers.
• Streamline the AR processes: Collection departments that share information about aging invoices with the credit and sales teams report lower collection costs per customer. Information about customers and invoices stored and accessible from a single platform enables the different teams involved to make coordinated decisions on sales, credit terms, trade discounts, etc. to enable faster collections at lower costs. AR software solutions can help automate the workflows to get approval from different teams as well as ensure that robust credit risk assessment is completed before credit terms are approved. 

Optimizing collection costs is crucial

Collecting unpaid invoices alone isn’t enough. You also need to monitor the cost that goes into collections.

Maximizing the $$$ volumes collected within the credit period, be it 30 days or 60 days, is crucial to minimizing collection costs. This in turn helps you improve your profit margins. 

As discussed in the previous sections, collecting an invoice that is due for 90 days is 50 times more costly than collecting it during its credit term. 

Where would you want these dollars to be recorded – in your income account or expense account? 

Appendix

*Key assumptions used for calculating the cost of collections:

1. The total revenue of the company is $100 Mn
2. The number of invoices processed every year is 100,000
3. The average invoice amount is $1000
4. The average past-due percentage of invoices is 35%
5. The hourly FTE salary is $15
6. The WACC percentage is 4%. WACC costs are calculated as: (Total amount due in the respective bucket * 4% * average days past due for the bucket)/365
7. The cost of a phone call is 2 cents per minute. The average call duration is 7 minutes.
8. The number of collectors is one
9. The standard credit period is 60 days
10. Aging invoices are spread across the buckets (0 – 30 days, 31 – 60 days, 61 – 90 days, > 90 days) in the proportion 50%, 30%, 15%, and 5%, respectively. The proportion of time/salary costs spent on each bucket is assumed to be in the same proportion as the dollar value of invoices in each bucket.