Collections Effectiveness Index: How to Act on It

What is Collection Effectiveness Index?

Collections Effectiveness Index(CEI) is a popular metric across industries that gives the Order to Cash leaders a better understanding of how their A/R teams perform. Collection Effectiveness Index can be simply defined as “The percentage of account receivables that are collected in a given period of time.”

The CEI provides a clear understanding of the performance of the Credit and Collections teams. A higher CEI indicates that the organization incorporates a strong credit policy and effective collections process.

What is the Difference Between Day Sales Outstanding and Collection Effectiveness Index?

Day Sales Outstanding(DSO) and Collection Effectiveness Index(CEI) both are critical metrics that are monitored by the credit and the collections teams. Let us understand how these metrics are different from each other.

What is the Formula for Collection Effectiveness Index?

Collection Effectiveness Index is calculated by dividing 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

First, let’s define some terms we will use to explain the formula.

• Beginning receivables is the amount in Account Receivables at the beginning of the period.
• Monthly credit sales is 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 :

Collection Effectiveness Index Calculation sample data :

• Beginning receivables=$6000
• Monthly credit sales=$4130
• Ending total receivables=$6200
• Ending current receivables=$4000

Calculating Collection Effectiveness Index :

Therefore, the CEI for three months would be 64%.

Collection Effectiveness Index Calculator

Want to improve your Collection Effectiveness Index?

Check out the tried and tested tips to improve the collections effectiveness index.

Understanding the Importance of Collection Effectiveness Index

1. Clarity on Your Payment Collection Practices

Collections effectiveness index is the KPI that quantifies the robustness of your payment collection system. With a low CEI, the upper management ends up comprehending that the Credit and Collections teams need to perform a lot of course corrections in their day-to-day operations. It helps to understand the importance of collection efficiency.

2. Timely Assessment of Your Collection Policies

The 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 on a monthly basis, but you can also use it to assess the quality of your collection efforts over longer periods of time.

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 behaviour should be used to create various customer segmentation buckets. Every customer segment would have its specific credit and collection policies.

3. Absence of Flexible Payment Formats

Customers might have diverse payment preferences. Are you able 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

  How much time do your Credit and Collections analysts spend per day figuring out which calls they need to make? Most of the collectors are victims of a lack of customer prioritization, and most of the time, they end up calling the wrong customer, which delays the payment.

• Reactive Collections Practices

  Most Credit & Collections analysts call up the customers or send payment reminders when the invoices are overdue. Ideally, they should send proactive reminders as the due date approaches and not wait for the payment delay.

How to improve the Collection Effectiveness Index?

Understanding collections effectiveness index and computing it consistently will let you know 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.

With the right tool, you can optimize the credit and collections process, thereby improving the Collection Effectiveness Index.

FAQ

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.