| What is debt collection? | Debt collection is a set of steps taken by a creditor to obtain payment of an unpaid invoice from the debtor. |
| Why manage your receivables? | Good management of your company’s receivables is essential for good financial management, especially cash flow. |
| What recovery techniques are available? | There are two main types of collection techniques: amicable collection and judicial collection. |
| Which receivables are eligible for collection? | To initiate collection proceedings, the debt must be certain, liquid and due. |
Debt collection plays a key role in a company’s financial management. Effective receivables management is vital to financial stability, and particularly to cash flow management. To achieve this, it is essential to monitor the performance of your collection strategy. KPI analysis is an essential step in receivables management. That’s why we invite you to discover which indicators are essential for monitoring debt collection, as well as the tools and best practices to adopt.
The fundamentals of debt collection
Before looking in detail at the key indicators you need to follow to collect your company’s receivables, it’s essential to keep in mind all the steps involved in the collection process. Here’s what you need to know:
- identify overdue invoices;
- carry out the first customer reminder, whether by telephone, e-mail or letter;
- sending your customer a formal notice by registered mail with acknowledgement of receipt;
- the decision to refer the case to legal collection if the customer fails to respond;
- initiate legal debt collection proceedings, depending on the situation (injunction to pay, small claims collection, provisional injunction, etc.).
It’s essential to follow all these steps to optimize debt collection. Unpaid customer invoices have a direct impact on a company’s cash flow, since the expected cash inflows are not realized. This in turn can lead to cash shortfalls, which in turn can lead to cash shortfalls, which in turn can lead to suspension of payments.
What’s more, it’s very important to have a good collection process to avoid any risk of a debt becoming time-barred. This would prevent the company from taking legal action against the debtor on the grounds that the debt has been legally extinguished.
Last but not least, having an efficient, well-constructed collection process helps to preserve the commercial relationship with customers, even in the event of difficulties.
In view of these factors, receivables management is a must for any company. It needs to be able to assess the performance of its collection processes, identify strengths and weaknesses, and take corrective action where necessary. To carry out this analysis, it is essential to refer to certain KPIs.
Key KPIs for debt collection
The main indicators to be monitored to assess good accounts receivable management are :
- DSO (Days Sales Outstanding) ;
- aged trial balance ;
- collection forecasts ;
Collection Effectiveness Index (CEI); - recovery rate;
Litigation rate; - average life index of receivables;
- cost of collection per receivable.
Daily Sales Outstanding (DSO)
Days Sales Outstanding (DSO) is an essential indicator in receivables management. It measures the average number of days between invoice issue and payment.
As a result, DSO includes both invoices paid on time and those paid late. Knowing your company’s DSO enables you to estimate your working capital requirements (WCR). In fact, the higher the WCR, the greater the risk of the company needing cash advances to pay its own expenses, and vice versa. That’s why the objective is to reduce DSO as much as possible. One way of achieving this is to introduce shorter contractual payment terms.
To calculate DSO, you can use one of the following formulas:
- formula for calculating DSO using the accounting method: accounts receivable (incl. VAT) for a period / sales (incl. VAT) for the same period X number of days in the period.
- formula for calculating DSO using the exhaustion method: accounts receivable (incl. VAT) – sales (incl. VAT) for month M – sales (incl. VAT) for month M-1… until customer balance is exhausted.
The ageing scale
The aged trial balance is a table that lists all overdue customer receivables and indicates the duration of the delay by category:
- less than 30 days past due ;
- between 31 and 60 days past due;
- between 61 and 90 days past due;
- more than 90 days past due.
This indicator is very useful for monitoring invoice payment, but also for establishing dunning priorities. The longer receivables are overdue, the more urgent the need for dunning. To prevent receivables from falling too far behind without action, it is possible to automate collection using collection software such as CashOnTime.
Forecast cash receipts
Next, for receivables management, you need to know your cash flow forecasts. This simply means anticipating cash inflows and outflows. To do this, you can rely on your knowledge of your customers’ payment behavior, as well as on the treasury tools at your disposal.
Collection Effectiveness Index (CEI)
The Collection Effectiveness Index (CEI) stands for Collection Efficiency Index. As its name suggests, it measures the performance of your debt collection process.
It is the ratio between the amount of receivables paid and the amount of receivables to be collected over a given period.
If your CEI is too low, it’s a sign that you need to review your collection policy, and possibly the organization of this activity within your company, in order to avoid major cash flow problems.
Recovery rates
In receivables management, the recovery rate formula is as follows:
Recovery rate = ((total amount to be recovered at the beginning of the month – amount still to be recovered) / total amount to be recovered at the beginning of the month) x 100
This is also known as the recovery rate. A high recovery rate reflects the good performance of the collection process in place. The objective is to approach 100%. On the other hand, a low recovery rate indicates the need to review the collection organization, and to raise awareness of the cash culture.
Litigation rate
The dispute rate corresponds to the number of disputed invoices in relation to the total number of invoices issued over a given period.
Calculating the dispute rate enables you to manage disputes proactively, and thus optimize collection.
The aim is to achieve the lowest possible dispute rate, not only to ensure the company’s financial stability, but also to preserve customer confidence.
Average life index of receivables
The average life of receivables index measures the average time taken to collect a receivable. The company should aim for the lowest possible index, in order to reduce its DSO.
Thanks to this indicator, the company can optimize its cash flow by encouraging faster cash receipts, even in the event of delays. To achieve this, a high level of responsiveness is essential as soon as late payment is detected.
Cost of collection per receivable
The final key indicator for receivables management is the cost of collection per receivable. This involves determining how much it costs to collect a debt. This includes personnel costs, legal fees and, where applicable, court costs.
An analysis of the costs associated with the collection process should enable us to verify that the actions taken are profitable for the company. Indeed, the company must seek to reduce collection costs. To achieve this, the productivity of debt collection teams must be enhanced. Dedicated tools, such as collection software, can be an effective way of improving collection performance and efficiency.
KPI tracking tools
Receivables management software is an invaluable ally when it comes to tracking performance indicators and optimizing debt collection. Indeed, this type of software enables you to take advantage of the benefits of automated collection, such as time savings, responsiveness and cost control.
On the other hand, collection software like CashOnTime gives you access to dashboards tailored to your needs. You can easily monitor key performance indicators in real time. You’ll have a global view of your debt collection KPIs, enabling you to react quickly and make the strategic decisions you need to keep your business running smoothly.
Best practices for KPI optimization
Finally, to ensure effective receivables management, here are a few best practices to adopt:
- regularly analyze collection KPIs ;
- make the necessary adjustments and take corrective action based on observed results;
- communicate effectively with the relevant departments (accounting, collection and sales).
Conclusion
Good accounts receivable management requires analysis of key KPIs such as DSO, aged trial balance, collection forecasts, CEI, recovery rate, dispute rate, average debt life index and cost of collection per receivable. Analyzing and monitoring the information provided by these KPIs is essential for optimizing receivables management.
