Measures of Performance - Credit and Collections

In many of our engagements, presentations and workshops, we discuss several commonly-used measures which are used to analyze financial and operational performance. These measures include credit and collections calculations like Days Sales Outstanding (DSO) and Collection Effectiveness as well as customer care metrics like Percent Abandon or Average Occupancy.

We include these measures here with explanations. We are also working on providing you with the ability to input your own data to get an immediate result. Check the News page for an announcement on when that will be relaeased.

Days Sales Outstanding (DSO)

Days Sales Outstanding (DSO) is a measure of the average number of days it takes to collect sales from customers. There are at least two ways to calculate DSO. The easiest way to calculate DSO is to use the following formula:

DSO =	(Ending Receivables) X (Days in Period Measured)
	Credit Sales in Period

The other way to caculate DSO is to track all customer payments and due dates and take the exact calculation based on billing and payment events in your billing system. While this way my be the most accurate way to calculate DSO, unless your existing system is already configured to calculate the value, the effort required to perform the calculation this way outweighs the increased accuracy.

The best way to use DSO is to track period over period changes in the measure. That's why the easier method makes the most sense to use. It may not be accurate to 4 decimal places, but by tracking it each month or each quarter, you can get a sense for whether your collections efforts are improving or declining.

Collections Effectiveness Index (CEI)

The Collections Effectiveness Index is a measure of how well your collections operation is functioning over time. The result is expressed as a percentage where the closer the result is to 100% the better the results. The formula for CEI is:

CEI =	Beginning Receivables + (Sales/N) - Ending Total Receivables
	Beginning Receivables + (Sales) - Ending Current Receivables

The easiest way to think about CEI is to look at it as the change in total receivables over the change in current receivables. In other words, how well is the collection operation keeping receivables from aging (i.e., stopping total receivables from growing after removing the effect of credit sales in the period).

Net Bad Debt (as a Percent of Sales)

The Net Bad Debt (NBD) percentage measures how well the receivables are being managed in the aggregate. NBD is a trailing measure of losses as a percent of sales. The calculation for NBD is:

NBD =	(Uncollectibles - Recoveries +/- Adjustments
	Sales in the Period

While it is important to track net bad debt, being a trailing measure, there is little that can be done to affect the immediate result. Losses are only accounted for when a receivable is deemed uncollectible. This is when either accounting rules or the organization has decided that it is no longer reasonable to expect payment. In some cases, this can be 6 months or more after the initial sale. Thus, actions taken as a result of a change in NBD will show up in the results 6 months later.

Average Days Delinquent (ADD)

Another measure similar to DSO, the Average Days Delinquent (ADD) is a measure of how long after the invoice due date customers are paying their bill. This measure also requires you to calculate the Best Possible DSO or average payment terms. Whereas DSO measures total outstanding receivables as a percent of sales, the Best Possible DSO is a measure of the current receivables in a period as a percent of sales. Average Days Delinquent is the difference between DSO and Best Possible DSO. In other words;

ADD =

DSO - Best Possible DSO

Deposit Coverage

One measure that is less common but a measure that we like to use is Deposit Coverage. Deposit coverage is an expression of the margin of risk that exists in the receivables portfolio covered by deposits. In other words, if all delinquent receivables went to charge-off, how much is being held in deposits that can be netted against the write-off to offset losses. The reason this measure is less common is that it only applies to companies that hold deposits against potential losses. Deposit coverage is calculated as:

Deposit Coverage	Deposits held
	(Total Receivables - Current Receivables)

Collections Cost per Delinquent Account

Operational measures examine the cost of collections in relation to the efficiency of the operation. This measure examines the unit cost of collections, including agencies and legal fees, being spent on all delinquent accounts. The best way to use this measure is to evaluate it in conjunction with collections effectiveness and DSO. In other words, if you increase spending, will CEI and DSO improve? By looking at these measures together, you will be able to assess whether you are overspending or underspending for collections.

Cost per Del Customer =	(Department Budget + Agency Fees + Legal Fees)
	Customers in Arrears

This measure can also be refined by looking at internal costs only or external agency costs.

Collections Cost per Dollar Collected

Probably the most important unit cost calculation, the cost per dollar collected measures if you are spending more than you are collecting. The calculation is very straight-forward.

Cost per $ Collected =	(Department Budget + Agency Fees + Legal Fees)
	Dollars Collected in Period