For businesses, B2B debt collection can be tough. To do it effectively, you have to first know exactly how well you're doing. Once you have a benchmark, you can start testing different collection methods to see if you improve your score.
One of the best ways to measure how well you're doing in collecting your outstanding debts is known as the Collections Effectiveness Index.
What is CEI, and How Does it Work?
Beginning Receivables + Monthly Credit Sales – Ending Total Receivables divided by Beginning receivables + Monthly Credit Sales – Ending Current Receivables
This quotient is then multiplied by 100.
The end number is a percentage, which tells you how effectively your business is collecting receivables during a set amount of time.
Of course, the closer your business is to 100 percent, the more effective your collection efforts.
This also means that your business likely has more working capital available to re-invest into your business or your employees.
The Benefits of CEI
One of the primary benefits of CEI is that it shows your business’ performance in collecting receivables. It also shows how quickly accounts receivables turn into closed accounts. Of course, the faster this conversion occurs, the better it is for your business.
On the other hand, if the percentage is lower or you notice your CEI is dropping, then this should cause a red flag. This typically means that something is preventing your business from closing open accounts.
However, CEI isn’t the only way to measure how well your business collects receivables and closes accounts. Another popular method used by bookkeepers and accounting professionals is Day Sales Outstanding (DSO).
Understanding how Days Sales Outstanding (DSO) works in contrast to CEI is critical for businesses that wish to boost cash flow and ensure that it is always in the black.
What is the Difference Between CEI and DSO?
The formula for DSO is simple:
Accounts Receivable divided by Total Credit sales. The quotient is multiplied by 365 (days).
In this case, DSO tells you how many days it takes your business to get paid (on average). This is a very important statistic to understand because if your business functions on 30-day billing cycles but it takes 60 days to get paid, this shows a flaw in the way your business operations. That said, DSO doesn’t measure fluctuations very well. CEI allows for more fluidity and measures the percentage of payments collected.
Which is Best for My Business?
Many businesses use DSO as a standard accounting practice. However, CEI is widely gaining popularity due to its ability to measure the effectiveness of a business’ collection patterns. Because DSO only measures the cash flow turn-around, the issue becomes noting where fluctuations occur. So, if a business experiences a month with lower sales or lower collections, then DSO could swing wildly while CEI is a bit more stable.
Some businesses use both DSO and CEI in tandem. This gives businesses great insight and appears to make up for where the other measurement may be lacking.
For example, if your business is cyclical in nature, then DSO may not be the best form of measurement. This allows for the opportunity to integrate CEI. CEI tells businesses their overall effectiveness in collections instead of the number of days it takes to collect.
Because cyclical businesses (should) build the high and low tides into their business plans, DSO may be an irrelevant measurement; these businesses want to ensure effective collections.
Conversely, businesses that want to see how quickly they are getting paid would find CEI to be lacking. Businesses that are striving for healthy and steady cash flow likely want to see how quickly they get paid in order to possibly change their ordering practices or budget properly for billing. CEI doesn’t provide businesses with insights into how quickly they get paid.
DSO, meanwhile, provides businesses with a realistic idea of how long it takes to get paid (in days). The smaller number of days, the better. If the number of days increases, then this could indicate collections issues.
In summary, CEI is a fantastic way to measure the effectiveness of your collections department. Because CEI is subject to change, it is always important for businesses to keep an eye on it in differing cycles. By keeping your CEI as close to 100 percent as possible, you ensure that your business is getting paid for its goods and/ or services. Using DSO is also helpful, though this is an older tool and it may not be designed for all businesses.
Finally, using both CEI and DSO will ultimately provide your business with exceptional, useful insights into your cash flow, helping you to allocate your working capital in the most beneficial ways to ensure continual growth.