You’ve got a solid business that sells on credit and makes a nice profit doing it. That assumes, of course, that you get paid substantially all of your accounts receivable, even though some of your customers may want to use that money elsewhere, and others would prefer not to pay you at all. How do you keep everything on track? Here’s how.
First, there are four key KPIs to watch – not just one – so you can quickly see if your AR collection effort is flagging. They are:
- Total Past Due AR as a percent of the Total AR. While the AR aging report is the tool most companies look at first to monitor their collections, they don’t always pay attention to what it tells them. If your past due AR is more than 25% of the total, as an example, you’re probably not paying close enough attention to it. This is your interest-free lending to your customers, and you should employ it wisely. What that number should be is, of course, a function of your industry and normal collection patterns. But regardless, don’t stop there.
- Aged Trial Balance of AR by Period – what percent of your AR dollars are 30 days past due, what percent is 60 days past due, 90 days, etc. Historically, and logically, the older a balance remains uncollected, the lower the likelihood that it will be paid in full, for whatever reason. You should expect that the dollars that are 60 days past due are less than the dollars that are only 30 days past due. The smallest total dollars, if there are any, should be in the 90+ range.
- Days Sales Outstanding (“DSO”) – meaning the number of average days sales you have sitting in AR, calculated simply as your average daily sales divided into your total AR. What that should be also depends very much on your industry. Tech companies who sell subscription services and get paid by credit cards will likely have a DSO in the 15-20 day range, while a toy manufacturer whose big season comes once a year might have a DSO in the 90-100 day range or more. But in general, you should consider a reading under 45 days as a traditional measure of good results.
- KPI Trends – are those metrics moving in a positive or negative direction? That means tracking them over time, with each monthly financial report, and noticing if:
- Total past due balances have been increasing as a percent of the total, or
- DSO was at 40 days and then went to 42 days and now just hit 44 days, or
- Unpaid balances over 60 days were 20% of the total, and then moved to 24%, and now just came in at 26%.
Those small changes in trends are a warning not to be ignored.
So how do you fix it?
We’ve seen this problem so often in new client engagements, and the #1 reason is because collection follow up is not the key responsibility of anyone, or it’s everyone’s responsibility when they have free time. Hint: NO ONE will have much free time if that means trying to collect money from past due customers, getting in the middle of their reasons for not paying, having to push back against the worst slow payers, etc. No one wants to do that job, so unless it’s a key responsibility of someone, whose job performance is directly related to effective collection success, good luck. Ultimately you may have to make a decision to pursue collection or not sell to that customer, and then you and the customer both lose. Bad outcome all around.
How do we know this? Because we’ve seen it and fixed it a hundred times. Because, after all…
We are Your CFO for Rent.