In many businesses one of the most important assets, and perhaps the largest, is accounts receivable (A / R) after cash, which is probably the closest thing to money in the bank.
The time it takes for an account receivable to become cash through payment is important to ensure the protection of cash flow and is also often a means of measuring the type of work being carried out by account management for charging, knowing these measures is not always an easy task.
When credit is granted, an account receivable is created and placed on the left side of the balance sheet along with other assets, a commonly accepted business practice, can make it difficult to clearly identify how fast those payments are being made, I I am referring to the portfolio days indicator (DSO) since this is often used to measure the return time of Accounts Receivable, but it has some shortcomings.
Using the Portfolio Days indicator to measure the return time of credit sales is like taking a population census. When sales increase and new accounts receivable are created, it is like a population boom, since the average age of that population (or Portfolio Days) decreases. On the other hand, a drop in sales means fewer new accounts receivable (equivalent to the birth of fewer babies) and these are added to the previous ones, which causes the average age of the population and the Portfolio Days to increase.
The problem with the traditional Portfolio Days Indicator is that it is a “Post-Fact” measure and we cannot change history.
A simpler and more precise formula to calculate the return time of an account receivable, progressively provides the reaction of the real time of recovery of the collection.
This formula is, the Collection Days Index (CDI for its acronym in English Collection Days Index) is equal to the term of sale by the percentage of collection at the end of the month.
Is that how it works
Stage one. We will start with the total portfolio start balance at the first of the month. This means, all accounts receivable on the last day of the previous month regardless of whether they come from outstanding balances from previous months.
New credit sales made during the current month will be considered in the total beginning balance of the following month. For example, our total portfolio balance at the first of the month is $ 1,000.00 and it concentrates all the accounts receivable that the company has as of the last day of the previous month.
Stage two. Keep track of the collections made on those invoices that make up the total balance of the beginning of the portfolio.
During the key dates of the month (say days 10 and 20), calculate the percentage of collections from that date by dividing the amount collected by the total balance of the portfolio start
If we are on the 10th day, for example, suppose we have collected $ 200.00 of the total starting balance of $ 1,000.00, our collection percentage is 20 percent as of that date, it is important not to mix the collections that could have been made from invoices issued that same month. or cash sales.
We can compare the collection percentage on the 10th of this month against that of the 10th of last month. If the previous percentage was higher, it does not necessarily mean that we are doing a bad job.
It is important to understand that it is not a question of good or bad, but rather to ask ourselves "Why is this result happening?"
A lower collection percentage may be the result of several factors, for example, the person in charge of these accounts is on vacation without anyone following up with his clients, or it may be a matter related to a product or service with a business value lesser that was sold to someone with a payment record not exactly perfect, but that guarantees a greater profit.
Now, if we are already on day 20 and have collected $ 400.00 of our $ 1,000.00, our collection percentage as of that date is 40 percent. By tracking the collection percentage during the month, we can determine if we need more effort. It is like a seller who is well below his quota in the third week of the month, he has only one week to reach the goal.
Stage three. At the end of the month, calculate the CDI by dividing the collection percentage by the term of sales.
Let's assume at the end of the month we have collected $ 500 from our total starting portfolio of $ 1,000. Our collection percentage is 50 percent. If we are selling in 30 day terms, our CDI would be 60 days.
If we have varied terms of sale, we must calculate the CDI for each one and then take the average just as it can be done with DSO. (Portfolio Days)
There are numerous advantages to using the CDI on Portfolio Days. For example CDI turns out to be a more accurate measurement when calculating the actual recovery time for accounts as it is based solely on uncollected credit sales. It also provides a way to track charges throughout the month. And, it lets you know if corrective action needs to be taken in time to reach the goal.
Remember that at home or at work, it is important to know when your money comes in.
These are just some brief reflections based on the Profit System on B2B Credit Management, which is considered the latest revolution in credit management and collection, and without a doubt, from its founder Abe WalkingBear will be the international Standard for this sector in the coming years..
To know more.
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