In many businesses, Accounts Receivable are one of if not
the largest asset. Next to cash on hand, the A/R is probably
the closest thing to money in the bank. The time it takes for
the A/R to turn around and be collected is important for accurate
cash flow projections and as a gauge a way of measuring
what kind of job is being done in managing A/R.
DSO, the Old Way
DSO (Days Sales Outstanding) has been used to measure A/R
turn time for a long time, but it has some failings.
When credit is extended, (a sale made on the basis of payment
at a later date) we create an A/R (account receivable). A/Rs sit
on the right side of the balance sheet along with the other assets;
the liabilities sit on the wrong side.
Using DSO to compute the A/R turn time is like putting all
A/Rs into a box.
In a month when sales increase, we put more new A/Rs into the
box. It’s like a population boom, and the average age and DSO
go down. A drop in sales means fewer new, young A/Rs being
placed in the box, and the average age and DSO go up.
The failing of DSO is that it is an after-the-fact measurement,
and we can’t change history—not yet.
CDI. The New Kid
There is a simpler formula than DSO for computing the turn
time on AR, and it’s more accurate and
provides ongoing and real-time feedback
on collections. CDI (Collection Days
Index) is equal to the Terms of Sale Step Two
divided by the end of month Collection
Percentage, here’s how it works:
CDI =
Terms of Sale (for each term of sale)
Collection Percentage (end of month)
Step One
Start with the beginning total A/R balance
as of the first of the month. This
means all A/Rs, regardless of age. Any
new credit sales made during the month
will be picked up in the next month’s
beginning total A/R balance.
For example, our total A/R balance as of
the first of the month is $1,000.
Step Two
Track collections (payments and credits)
on those invoices that make up the
beginning total A/R balance.
During key times of the month (the
10th and the 20th), we want to compute
the Collection Percentage as of that
date by dividing the amount collected
by that date by the beginning total A/R
balance.
For example: If, by the 10th we have collected
$200 of the beginning $1,000
total balance, our collection percentage
as of the 10th is 20 percent. We can
compare this month’s 10th-day collection
percentage against last month’s
10th-day collection percentage. If last
months 10th-day collection percentage
was 40 percent and this month it’s 20
percent, it doesn’t mean that we are
doing a poorer job this month than
last. If there’s a great variation
between this month’s collection
percentage and last month’s collection percentage,
it’s not a matter of good or bad, but of why?
A lower collection percentage may be
due to the A/R person going
on vacation and no one following
up on past due A/R. It
may be a matter of a product/service
with a lower Product Value being sold to
someone with less than perfect past performance
(see sidebar on page 75).
If by the 20th we’ve collected $400 of
our beginning balance of $1,000, our
collection percentage as of the 20th is 40
percent. By tracking the collection percentage
during the month, we can determine if we need to exert greater efforts.
It’s like a sales guy who by the third week
of the month is way behind his sales
quota, knows he’s got a week in which
to turn the month around. If we are not
happy with the collection percentage as
of the 20th, we have 10 days to turn it
around.
Step Three
At the end of the month, compute the
CDI by dividing the collection percentage
into the terms of sale.
For example: At the end of the month,
we have collection $500 of our beginning A/R total of $1,000, our collection
percentage is 50 percent or 0.5. If we are
selling on 30-day terms, our CDI would
be 60 days.
CDI =
Terms of Sale (for each term of sale)
Collection Percentage (end of month)
If you have varying terms of sale, you
must compute the CDI for each and
then average them out, just as you
would do with DSO.
The advantages of CDI over DSO are
(1) A more accurate and real time measurement
of A/R turn time, and (2) A
way to track cash flow (collections) during
the month, and the ability to know
if corrective action has to be taken to
turn the month around.
At home or on the job, it’s important to
know when your money comes
in.
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Not All Bad Debt Is Bad
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About the Author
Abe Walking-Bear Sanchez is an International
Speaker/Trainer on the subject of
cash flow/sales enhancement and business
knowledge organization and use.
Founder and president of www.armgusa.com, Sanchez also sits on the board
of www.BestBizways.com Inc. He has
conducted programs for many groups,
including the “Inc.” Magazine Annual
Business Conference, IBM, STAFDA,
Pet Industry Distributors Association,
Winroc and Johnstone Supply.
