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Key Takeaways
- CEI tells you how good your company is at collecting money. A high CEI means things are going well, but a low one means you need to fix your collections process.
- To enhance your CEI, consider automating invoice delivery, offering diverse payment options, and implementing robust collections processes for delinquent accounts.
- Utilizing the right accounts receivable automation solution can significantly boost your CEI.
Introduction
The Collection Effectiveness Index (CEI) is a crucial metric used to assess a company’s ability to collect payments from its customers. It serves as an invaluable tool for monitoring a company’s financial performance.
However, when combined with Days Sales Outstanding (DSO), it becomes even more valuable, providing a comprehensive perspective on credit and collections.
In this blog, we will cover everything you need to know about this metric – from its definition and calculation to how to interpret and improve it. Let’s get started.
What is Collection Effectiveness Index?
Collection effectiveness index is a popular metric across industries that gives the Order to Cash leaders a better understanding of how their A/R teams perform. The Collection Effectiveness Index can be simply defined as “The percentage of account receivables that are collected in a given period.”
The CEI provides a clear understanding of the performance of the Credit and Collections teams. A higher CEI indicates that the organization has a strong credit policy and an effective collections process.
What is the Difference Between the Day Sales Outstanding and Collection Effectiveness Index?
Day sales outstanding and collection effectiveness index both are critical metrics that are monitored by the credit and collections teams. Let us understand how these metrics are different from each other.
What is the Formula for Calculating Collection Effectiveness Index?
Collection Effectiveness Index is calculated by dividing the beginning AR balance + monthly credit sales – ending AR balance by the sum of beginning AR balance + monthly credit sales – (ending AR balance x payment term/30).
Breaking down collection effectiveness index
Let’s define the terms used in the formula
- Beginning receivables is the amount in account receivables at the beginning of the period.
- Monthly credit sales are how much money is made via sales in a particular month.
- Ending total receivables is all of the open receivables, including current and overdue receivables.
- Ending current receivables is the total of payments you received for credit sales made during the period.
Let’s further simplify the calculation of collections effectiveness index with an example :
Here are the values we will need to fill in the formula shared above:
- Beginning receivables=$6000
- Monthly credit sales=$4130
- Ending total receivables=$6200
- Ending current receivables=$4000
The CEI for three months would be 64%.
To make it easier for you to calculate collection effectiveness index we will be sharing the calculator in the next section.
Collection Effectiveness Index Calculator
Calculate Collection Effectiveness Index (CEI)
During the period, your company collected 0.00% of your available invoices on time.
Recommended Reading: 7 Best Practices To Ensure Faster Collections
Understanding the Importance of Collection Effectiveness Index
- Clarity on your payment collection practices
Collection effectiveness index serves as a crucial key performance indicator (KPI) that quantifies the strength of your payment collection system.
A lower CEI prompts upper management to recognize the need for significant adjustments in the day-to-day operations of the credit and collections teams.
It helps to understand the importance of collection efficiency.
- Timely assessment of your collection policies
Collection effectiveness index is a tangible key performance index if you want to understand the effectiveness of your collection efforts.
You can use the CEI formula to examine the quality of your collection efforts every month, but you can also use it to assess the quality of your collection efforts over longer periods.
How to Interpret Collection Effectiveness Index?
CEI is an indicator of your collectors’ performance, but are you interpreting it correctly? What if your collector’s efforts are not translating into a good CEI? Let’s look at a few parameters that might be responsible for the exception:
1. Incorrect or delayed invoicing
Would a customer pay if the invoice was not received on time or if the invoice data were incorrect? They might not. It is preferable to track and double-check invoice information before contacting the customer.
2. Weak credit policies and lenient payment terms
Flexible credit practices and lenient payment terms could result in a low CEI. Customer payment behavior should be used to create various customer segmentation buckets. Every customer segment should have its tailored credit and collection policies.
3. Absence of flexible payment formats
Customers might have diverse payment preferences and you need to address their unique payment preferences. The absence of flexibility in payment options might impact cash collection schedules.
4. Lack of customer portfolio prioritization
- Collection strategies
Do your credit and collections analysts spend considerable time each day determining their call priorities? Often, collectors face challenges due to inadequate customer prioritization, resulting in calls to the wrong customers and payment delays. - Reactive collections practices
Typically, credit & collections analysts contact customers or send payment reminders only after invoices become overdue. Ideally, they should proactively issue reminders as the due date approaches, rather than waiting for payment delays to occur.
How to Improve the Collection Effectiveness Index?
Understanding collection effectiveness index and computing it consistently will help you figure out what you might need to modify in your collections practices.
Based on the patterns of how CEI is changing across months or quarters, you would be able to come up with a strategy on how to improve your collections strategies. But as a beginning point, every AR team should consider, the following:
In summary, to enhance your collection effectiveness index you need to optimize the credit and collections process.
This can be easily done by leveraging an account receivable automation solution as they can streamline your collections processes, leading to a significant improvement in your CEI.
This streamlined approach fosters efficiency and effectiveness in managing collections.
FAQs
1). What is a good collection effectiveness index?
A good collection effectiveness index (CEI) is an indicator that an organization is effectively managing its accounts receivable (AR) and collecting payments in a timely and efficient manner. A generally accepted benchmark for a good CEI is 85% or higher.
2). What is the difference between CEI and DSO?
CEI measures the quality of a company’s collection process, while DSO measures the average time it takes to collect payments.
3). What does CEI measure?
CEI measures the effectiveness and efficiency of a company’s collections process in converting outstanding invoices into cash, providing insights into credit and collections performance.
