7 Key Accounts Receivable Metrics That Are Important to Track

9 November, 2021
14 mins
Bill Sarda, Digital Transformation

Table of Content

Key Takeaways
Introduction
What Are Accounts Receivables Metrics and Why Are They Important?
7 Key Metrics to Track Your AR Performance
In Closing: Account Receivable Metrics
FAQs

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Key Takeaways

  • Effective accounts receivable management hinges on understanding and tracking key metrics such as DSO, ADD, CEI, and more.
  • Accounts receivables metrics provide vital insights into a company’s financial management, impacting cash flow, working capital, and profitability, while also serving as early warning signs for potential issues.
  • Discover the significance of each metric on how they contribute to robust bottom-line growth, ensuring a healthy financial future for your organization.
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Introduction

Managing accounts receivables effectively is crucial for any company aiming to run a successful business. The key to successful AR management is understanding and tracking key accounts receivable metrics. By monitoring the right metrics, you gain valuable insights into your company’s financial health, customer payment behavior, and collections efficiency.

In this blog, we will delve into seven essential accounts receivables metrics. Understanding these key metrics will empower you to navigate the complexities of effective accounts receivable management, regardless of your role within the organization. So, let’s get started.

What Are Accounts Receivables Metrics and Why Are They Important?

Accounts receivable metrics are financial indicators that provide key insights into a company’s effectiveness in managing its outstanding invoices and collecting payments from customers. These metrics help businesses gauge the efficiency and impact of their AR processes on overall financial health.

Effective accounts receivables management is critical for several reasons. It directly affects a company’s cash flow, working capital, and profitability. Timely and accurate collections from customers ensure that a company has the necessary funds to cover its operating expenses, invest in growth, and meet financial obligations, such as paying suppliers and servicing debt.

Furthermore, accounts receivables metrics serve as early warning signs for potential issues. By tracking these metrics, you can identify trends, assess risks, and make informed decisions to optimize their financial performance. Now, let’s delve into some key metrics that you should closely monitor.

7 Key Metrics to Track Your AR Performance

There are several metrics that you need to track to measure your accounts receivable performance. Here’s our list of the key metrics every AR team needs to track on a continual basis.

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1. Day sales outstanding (DSO)

Day sales outstanding (DSO) is a critical financial metric that measures the average number of days it takes for a company to convert credit sales into cash. In simpler terms, it represents the average time a company needs to collect payments from its customers after making a sale. DSO serves as a vital gauge of a company’s financial health and performance, highly regarded by financial experts.

Calculating DSO

The formula to calculate DSO is straightforward:

DSO = (Accounts Receivable / Total Credit Sales) x Number of Days

The significance of DSO

DSO’s importance lies in its direct connection to collections. Quicker cash collections result in improved cash flow, allowing the company to allocate the same funds to more high-value purposes. 

Conversely, a high DSO indicates that a company takes an extended period to collect what is owed, revealing potential issues with its collection and credit analysis processes. High DSO can even lead to difficulties converting receivables into cash, potentially resulting in bad debt write-offs.

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2. Average days delinquent (ADD)

Average days delinquent (ADD), also known as delinquent days sales outstanding, represents the average number of days that invoices remain overdue or past their due date. This crucial metric serves as a valuable tool for collections teams, enabling them to assess customer delinquency trends effectively.

Calculating ADD

You can calculate ADD using the formula:

ADD = Days Sales Outstanding (DSO) – Best Possible Days Sales Outstanding

The significance of analyzing ADD

Analyzing ADD is an effective way for companies to uncover potential cash flow challenges. It also highlights areas where tighter credit policies or improved collections processes may be needed. For instance, a high ADD might indicate extending credit to less creditworthy customers or inefficiencies in collections efforts.

Comparing ADD to industry standards or competitors’ metrics provides valuable insights. It helps companies identify areas where they might be lagging and prompts action to enhance their accounts receivable function for a more competitive edge.

3. Collection effectiveness index (CEI)

The collection effectiveness index (CEI) measures how effective a company is at collecting money it’s owed within a specific time frame. This vital metric evaluates the performance of your order-to-cash (O2C) team and helps you determine whether your current collection practices need a tune-up. Unlike DSO (Days Sales Outstanding), CEI isn’t about time; it’s about how well your business turns invoices into cash.

Calculating CEI

You can calculate CEI using this simple formula, which shows what portion of your receivables was collected compared to what should have been collected:

CEI = (Beginning AR – Ending AR) / (Beginning AR – Ending Current AR)

Significance of CEI

Tracking CEI isn’t just about numbers; it’s about making savvy choices. A higher CEI indicates that you’re adept at gathering owed money within your set time frame, ensuring a steady flow of funds into your business.

It also provides valuable insights into the effectiveness of your credit policies and collections practices. By paying attention to CEI, you’re equipped to make informed decisions that fine-tune your financial processes, ultimately contributing to your business’s success.

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4. Tracking high-risk accounts 

High-risk accounts are those that demand immediate attention and follow-up, as any delay or oversight could lead to bad debt. It’s of utmost importance to spot these high-risk accounts early and initiate communication to secure payments before the situation escalates.

The significance of tracking high-risk accounts:

Monitoring high-risk accounts is a fundamental step in evaluating a company’s operational efficiency. By categorizing customers based on factors like Days Sales Outstanding (DSO), credit limits, aging status, or past payment history, businesses can create targeted worklists.

These worklists pinpoint priority accounts that require prompt dunning and cash collection efforts. This systematic approach significantly reduces the risk of encountering bad debt.

Effective strategies for tracking high-risk accounts:

  1. Aging buckets: Prioritizing customers by aging—how long their payments have been overdue—helps identify accounts that are substantially behind schedule. This approach enables businesses to develop strategies for early collection.
  2. Payment history: Segmenting customers based on their payment track record distinguishes between on-time payers and late payers, streamlining collection efforts for each category.
  3. Value to the company: Customer segmentation by order value allows companies to identify high-paying customers, enabling personalized approaches to ensure their timely payments.

5. Accounts receivable turnover ratio (ART)

The accounts receivable turnover ratio is a fundamental financial metric that sheds light on a business’s ability to efficiently convert credit sales into cash. This metric plays a pivotal role in monitoring and optimizing cash flow, revealing how swiftly a business can collect its outstanding accounts receivables within a specific timeframe.

Calculating accounts receivable turnover ratio

Accounts Receivable Turnover Ratio = Net Credit Sales / Average Accounts Receivable

Why the accounts receivable turnover ratio matters

The accounts receivable turnover ratio is a powerful tool that helps businesses understand how well they collect money from customers. By regularly keeping an eye on this metric, companies can see patterns, make smart decisions, and improve how they handle their money.

A high ratio signifies efficient receivables collection, translating into superior cash flow management and an overall healthier financial condition. Besides, this metric also helps companies figure out if their customers are good at paying on time or if they might have trouble with their bills.

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6. Periodic credit reviews

Periodic credit reviews involve lenders regularly assessing their key customers at predefined intervals. These reviews serve the purpose of updating credit scores periodically and staying informed about the credit risk associated with their customers.

For instance, if Company B has a history of delayed payments, and a periodic credit review reveals that its financial condition is deteriorating, you may consider reducing the credit limit extended to Company B, thereby minimizing the risk of bad debt.

This practice revolves around evaluating the creditworthiness of vital customers, securing receivables, and adjusting credit limits accordingly.

Essential information for periodic credit reviews:

Several key pieces of information play a pivotal role in periodic credit reviews:

  1. Annual turnover: Tracking a customer’s annual turnover allows for a comparison of their current financial health with previous years. This data aids in predicting their creditworthiness and helps in tailoring credit limits based on their financial performance in the current accounting period.
  2. Payment history: Evaluating the payment history of existing customers is a cornerstone in assessing their creditworthiness. This analysis guides adjustments to credit limits based on the customer’s risk level.
  3. Credit data from credit agencies: Credit agencies provide lenders with essential information, such as a company’s financial health, payment records, collateral, and the overall economic climate. This data assists lenders in determining whether to extend credit and plays a crucial role in mitigating the risk of bad debt.
  4. Trade references: Assessing trade references from previous lenders or business partners helps determine whether it’s prudent to extend credit to a particular company. These references offer insights into the company’s reliability based on past interactions.

7. Cash conversion cycle (CCC)

The cash conversion cycle, often referred to as the CCC or cash cycle, serves as a critical measure of how long it takes for a company to transform its investments in production and sales into actual cash.

It’s important to note that the CCC’s duration can vary widely based on the type of business and industry.

Calculating CCC

CCC is calculated using the formula:

CCC = Days Inventory Outstanding (DIO) + Days Sales Outstanding (DSO) – Days Payable Outstanding (DPO)

Significance of CCC

CCC is a powerful tool for improving cash flow. By keeping a close eye on this metric, businesses can identify opportunities to reduce the time it takes to convert investments into cash. A shorter CCC means more readily available cash, which can be reinvested or used to meet financial obligations.

A well-managed CCC contributes to higher profitability. Streamlining the cycle reduces the need for excess working capital, potentially lowering financing costs. It also allows a company to take advantage of strategic opportunities and investments that can drive growth and earnings.

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In Closing: Account Receivable Metrics

As we’ve explored the world of accounts receivable metrics, we’ve seen that these numbers are more than just figures on a spreadsheet. They are the key to financial well-being, offering insights that can mean the difference between success and struggle.

The key AR metrics help you spot potential problems early, allowing you to steer your financial ship in the right direction. Whether you’re a CFO trying to improve cash flow or an AR manager working on efficient collections, these metrics are your trusted allies.

But the road to effective AR management isn’t always smooth. Manual processes, data scattered across different places, and the ever-growing complexity of business can make things tough. That’s where automation comes in as a game-changer. By automating your accounts receivable tasks, you can break down barriers between teams, get clear insights, and make smart decisions based on data.

HighRadius’ Autonomous Receivables offers a glimpse into the future of AR management. It simplifies your workflow, enhances decision-making, and ensures your financial health remains robust. Our all-in-one solution facilitates seamless collaboration among your AR teams, thus improving efficiency and accuracy.

Are you ready to embrace the future of AR management and secure your company’s financial health? Schedule a demo with us to experience firsthand how HighRadius’ Autonomous Receivables can transform your business.

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FAQs


1. How to track accounts receivable?

To track accounts receivable you need to maintain a detailed record of customer invoices and payments. Regularly reconcile the accounts, follow up on overdue payments, and generate reports to monitor outstanding balances. This helps businesses manage their cash flow and ensure timely collection of receivables.

2. What is KPI in accounts receivable?

KPI in accounts receivable measures the effectiveness of managing and collecting receivables. Common KPIs include DSO, CEI, ADD, CCC and Aging of Receivables. These metrics help businesses evaluate cash flow, customer payment behavior, and overall accounts receivable performance.

3. How do you measure accounts receivable performance?

Accounts receivable performance can be measured through various metrics such as Days Sales Outstanding (DSO), Collection Effectiveness Index (CEI), Aging of Receivables, and Bad Debt Ratio. These indicators help assess the efficiency of managing receivables, cash flow, and customer payment behavior.

4. What is the most commonly used tool to evaluate accounts receivable performance?

The most commonly used tool to evaluate accounts receivable performance is the Days Sales Outstanding (DSO) metric. By tracking DSO, businesses can assess their efficiency in managing receivables and monitor the effectiveness of their credit and collection processes.

5. What is accounts receivable tracking?

Accounts receivable tracking refers to the process of monitoring and managing the money owed to a business by its customers. It involves keeping records of invoices, tracking payments, reconciling accounts, and following up on overdue payments.

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