5 Key Performance Indicators for Measuring AR Efficiency and Effectiveness

Running a business with the intention of growing it and making it a success is like embarking on an ambitious but exciting journey. Like every other journey you will start in life, you will need milestones to help you keep track of the progress you are making as you travel. In a real-life business, we use Key Performance Indicators (KPIs) to track the progress we make in our journey. The journey is in the form of a strategic plan that contains a set of goals, performance indicators, targets, and initiatives that enable the achievement of the targets. As the title rightfully indicates, this article will focus on KPIs for the Accounts Receivable (AR) team in the Finance department of an organization.

The AR function is a crucial element of the finance team in any organization, be it a Profit or Non-Profit as it directly affects cash flow and overall profitability. Failure to effectively manage the AR function can lead to liquidity issues and hinder a company's ability to invest in growth and operations. The common metrics for this function focus on indicating the Efficiency and Effectiveness of your receivable collection process. Efficiency metrics aim to measure how well AR processes are executed and optimized; hence, they focus on minimizing costs and maximizing resource utilization. On the other hand, Effectiveness metrics measure how well AR processes contribute to the overall business objectives.

There are quite a lot of performance indicators to discuss under the AR function, depending on the size of the organization and its chosen business model. However, this article will only focus on key global ones that apply to diverse businesses and industries.

1. Average Days Sales Outstanding (DSO)

This measure is a financial ratio that measures the average number of days it takes for the AR team to collect payment for its credit sales. It indicates how long it takes for customers to pay the outstanding invoices. When analyzing the DSO KPI trend, a lower DSO signals that customers are paying their invoices promptly, which is generally a positive sign for the company's financial health, while the opposite is true for a higher DSO.

2. Aging of Receivables

This KPI indicates the length of time client invoices have remained unpaid and categorizes the invoices into standard aging buckets spaced by 15 days to 30 days, depending on the credit policy of the organisation. The aging analysis is very important as it provides insights into the quality of a company's accounts receivable and helps identify potential risks associated with uncollected payments. Invoices that are way beyond the acceptable payment due date signal a higher risk for bad debts. In AR weekly meetings, the aging analysis can guide collection efforts by highlighting which customers need immediate attention.

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3. Average Days Delinquent (ADD)

This is a financial ratio that indicates the average number of days that customer invoices remain beyond the agreed payment deadline before payment is received. It provides insights into the effectiveness of a company's credit and collection policies. A high ADD indicates that customers are taking longer to settle their invoices after they are due, and this potentially affects a company's cash flow and profitability negatively. The opposite is true for a low ADD.

4. Collections Effectiveness Index (CEI)

This KPI tracks the efficiency of a company's collections efforts. It compares the amount of cash collected to the total amount of outstanding receivables. When analyzing the trended KPI data, a high CEI suggests that the business is effectively collecting its outstanding receivables, which is a positive sign for its financial health. In contrast, the opposite is true for a low CEI.

5. Write off rate

This is a financial ratio that measures the percentage of total credit sales that become uncollectible and must be written off as bad debts. It indicates the effectiveness of a company's credit granting and collection processes. When analyzing trended KPI data for this measure, a low write-off rate indicates suggests that the company is effectively managing its credit risk and collecting its outstanding receivables, which is a positive sign for its financial health.

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When you track and analyze these KPIs, businesses can identify potential areas for improvement, optimize their AR processes, and enhance their overall financial performance. It is important to set specific targets for each KPI, regularly monitor trends, and benchmark to ensure that AR management is aligned with the 'organisation's strategic goals.

To learn more about developing, automating, and analyzing KPIs, sign up for our several in-house and open workshops. Email fspi@ipcconsultants.com to get detailed course content on Business strategy, Balanced Scorecard, KPI Report Automation, and Business Analytics workshops.

David Shambare is a Strategy and Performance Management enthusiast; he is a consultant at IPC. He enjoys researching topics related to business strategy, financial planning, and analysis as well as performance improvement. He is reachable via email at david@ipcconsultants.com or on our general lines 0242481946-10.