Is your A/R process overwhelming and all over the place? You might not know what to measure! Fortunately, the secret lies in introducing key performance indicators (KPIs) to ensure your AR performance is up to par. By focusing on a few essential metrics, you can avoid sifting through endless reports and accounts every time A/R becomes a problem. As a nice side effect, you may not only improve cash flow but also make your own life easier in the process.

Tracking relevant A/R KPIs can provide invaluable insights into AR processes. You'll be able to pinpoint areas for improvement and create strategies that truly make a difference. Unfortunately, not everyone realizes the importance of these metrics.

In the following sections, we'll explore the importance of KPIs in accounts receivable management and reveal 10 core metrics to keep an eye on. We made sure they're simple yet actionable. Ready? Let's dive in and unlock the potential of KPI-driven AR management!

Why KPIs Matter

Ever heard the saying, 'What gets measured gets done'? Well, it's true! You might think you have a good handle on your numbers, but seeing those key figures in black and white and reviewing them as a team can really make a difference. KPIs (Key Performance Indicators) are not just about collecting data – they offer valuable insights that help finance teams make better decisions, set goals, and stay on track.

Think of KPIs as your secret weapon in managing accounts receivable (AR). They go beyond data collection, providing actionable insights to ensure timely collections and safeguard your company's financial stability. And here's the fun part: a user-friendly KPI dashboard can be a game-changer for your reputation with management. Instead of drowning in reports, you'll present a concise and clear overview of the department's health, making them appreciate your brevity and clarity.

Want bonus points? Regularly bring up the KPIs and their trends to management. Show them you're not only doing your job well but also making a difference. So, let those KPIs guide you towards success and impress your higher-ups along the way!

Overview of Key Performance Indicators (KPIs)

Before diving in, let's take a moment to remind ourselves of the characteristics that define good KPIs in business.

KPIs, or Key Performance Indicators, are measurable values that demonstrate how effectively a company is achieving its key business objectives.

Good KPIs possess the following characteristics: relevance, measurability, actionability, timeliness, simplicity, comparability, and specificity.

You wouldn't want to choose KPIs that are irrelevant to your team or those that you can't influence. Many companies make the mistake of selecting the wrong metrics for their team e.g. just focusing on the number of sales for the A/R department. While this may be an important metric for the Sales team to track, the A/R team has no way of directly impacting sales through their role. This means that, in the example, # of new accounts sold wouldn't be an effective KPI for your A/R team to monitor.

With that being said, let’s jump in!

Here are the top 10 KPIs for measuring accounts receivable performance:

1. DSO, or Days Sales Outstanding, quantifies the average time required to collect payment after a sale occurs, providing an indication of your A/R team's efficiency in gathering outstanding receivables. You can calculate DSO with this formula: (Accounts Receivable / Net Credit Sales) x Number of Days in the Period. Easy enough, right? This is probably one of the most important/common metrics for A/R teams. You can read more about this topic here on our blog.

2. The Accounts Receivable Turnover Ratio is a measure that reveals the frequency with which a company's accounts receivables are collected and converted into cash within a given timeframe. This ratio is a reflection of the efficacy of credit and collection policies. As a simple formula, remember: Accounts Receivable Turnover Ratio = Net Credit Sales / Average Accounts Receivable in a given timeframe. Since you should already be keeping track of Net Credit Sales and Average Accounts Receivable, this ratio is easy enough to compute.

3. Collection Effectiveness Index (CEI): Assesses the ability of the AR department to collect outstanding receivables in a given time frame, highlighting the overall efficiency of the collection process. To calculate CEI, use the formula: (Beginning Receivables + Credit Sales - Ending Receivables) / (Beginning Receivables + Credit Sales - Ending Current Receivables) x 100.

4. Bad Debt to Sales Ratio: Represents the percentage of uncollectible receivables in relation to total sales, providing insights into credit risk management and the quality of the customer base. Calculate this ratio by dividing Bad Debt Expense by Total Sales and then multiplying by 100 to express it as a percentage.

5. Percentage of High-Risk Accounts: Identifies the proportion of customers who are more likely to default on payments, enabling the AR team to take proactive measures in managing risk exposure. High-risk accounts can be determined by analyzing factors such as payment history, credit scores, and industry-specific risk indicators. Divide the number of high-risk accounts by the total number of accounts to find the percentage.

6. Average Days Delinquent (ADD): Measures the average number of days that receivables are past due, serving as an indicator of the effectiveness of the company's credit and collection policies. To compute ADD, divide the total number of delinquent days for all past-due invoices by the total number of invoices.

7. Net Credit Sales to Average Accounts Receivable: Analyzes the relationship between credit sales and the average accounts receivable balance, providing insights into the company's liquidity and ability to manage credit sales. Calculate this ratio using the formula: Net Credit Sales / Average Accounts Receivable.

8. Number of Revised Invoices: Tracks the frequency of invoice revisions, which may indicate inefficiencies in the invoicing process or potential disputes with customers. To monitor this KPI, simply maintain a count of the invoices that have been revised within a specific period.

9. Operational Cost per Collection: Calculates the cost incurred to collect receivables, helping to identify areas for improvement and cost reduction in the accounts receivable management process. To find this metric, divide the total operational cost of the AR department by the total number of successful collections.

10. Cash Flow: This one is not technically a KPI for A/R teams, but an important financial metric. The A/R team's efficiency in managing and collecting receivables has a significant effect on the company's cash flow. While cash flow may not be a direct KPI for the A/R team, it is still valuable for them to be aware of the company's cash flow situation since their actions and policies can influence it. This may be a number to track/keep an eye on rather than an actual KPI on your dashboard.

That’s it! By keeping track of these top 10 KPIs, finance teams can gain a comprehensive understanding of their accounts receivable performance and use this information to optimize their AR processes.

Examples of KPIs for Accounts Receivable

In case you're still curious about the tangible impact these KPIs can have on your accounts receivable performance and which ones to pick— here are a few examples:

Example 1 — DSO: Company Acme Inc. started calculating DSO and noticed that their metric consistently exceeded the industry average, which hampered their cash flow. In a management meeting they decided to tighten their credit approval process and adopting a proactive collection strategy. Success! The measures they implemented successfully reduced their DSO from 45 days to 35 days and cash flow improved.

Example 1 — Bad Debt to Sales Ratio: SolarTech Innovations Corp. has been struggling with low cashflow and an alarming amount of bad debts. After analyzing their accounts they realized a large portion of their bad debts originated from a small group of high-risk customers in a specific industry. By reassessing their credit policies, limiting the credit terms for high-risk customers, and offering incentives for early payments, they managed to decrease their Bad Debt to Sales Ratio by 25%.

If you’re just starting out in this area, you may want to pick a few of them and implement the rest of the KPIs later. Start small! Next time you open your cashflow dashboard, check if there’s an opportunity to implement some of the above KPIs.

If your organization is already set up with most of these it may still make sense to take a look at these main KPIs and more than anything make sure that they are actually getting reviewed! Sometimes it’s not about whether these KPIs are getting calculated but about whether there’s a system/owner in place for acting on them.

Tools and Software for Measuring and Analyzing KPIs for Accounts Receivable

Now that we've discussed the importance of KPIs in accounts receivable management, you might be wondering if there are any tools out there to help you track and analyze these metrics. Well, that's where AR automation and analysis software comes into play! Fortunately, these days you don’t have to do everything manually.

E.g. Tools like Tesorio offer a range of features designed to help finance teams streamline and automate their A/R management. To make it a bit more specific we put together this table to show how a tool like Tesorio could help you keep track of the 10 main KPIs we discussed earlier:

Summary & Conclusion

In conclusion, monitoring KPIs is a vital component of effective accounts receivable management. By focusing on the right metrics, you can improve cash flow, reduce bad debt, and minimize operational costs. Utilizing tools and software like Tesorio can help you streamline AR processes and provide valuable insights to make data-driven decisions.

We hope this article has provided you with valuable insights and inspired you to consider implementing these KPIs and tools in your own organization. After all, isn't it time you unlocked the full potential of KPI-driven AR management?