In recent blog posts, we’ve discussed KPIs for various processes and even gave a concise description of what they are (see Guide to Managing Mergers and Acquisitions KPIs). In this post, we’ll be looking at KPIs again and this time it’s for Accounts Receivable (AR), Credit and Collections and we have a great document on KnowledgeLeader that goes more in-depth.
The simplest definition of accounts receivable is money owed to an entity by its customers. Correspondingly, the amount not yet received is credit and, of course, the amount still owed past the due date is collections. (Click on the link in that sentence for more documents on those topics.)
It’s pretty common for a company sell goods and services on an invoice basis with a future due date, often referred to as the payment term or terms, so dealing with credit process, and, unfortunately, collections processes, is also common. On a personal level, suppose you and your friend “Bob” went to lunch and Bob forgot his wallet so you covered lunch and he says he’ll pay you back Tuesday. If you’re of the accountant mindset, you might have mental balance sheet that with a line under “receivables” with a term of “Tuesday”.
Of course, a personal “IOU” with a friend doesn’t usually have best practices for the credit and collections process, even though maybe they should sometimes!
For a business, good process around receivables, credit and collections can be the difference between staying in business or not and with any business practice, there needs to be a well-defined and clearly stated set of business objectives. Monitoring and improving the business process to meet those objectives will require appropriate performance measures.
As discussed in previous articles, to do this a company will establish key objectives, outcome measures and activity measures.
Take a look at Process Accounts Receivable, Credit and Collections Key Performance Indicators (KPIs) on KnowledgeLeader for a great set of Key Objectives, Outcome Measures and Activity Measures.
Bad debt write-offs as a percentage of total sales
Formula: Bad Debt Expense/Total Sales
Analysis: This measure reflects the portion of goods or services that a company sold in a year for which payment will not be received. This allows a company to compare credit and collection effectiveness with other companies, regardless of size.
Companies with relatively high bad debt write-offs as a percentage of total sales may have room for improvement in the following areas:
Creating a credit evaluation policy that adequately uncovers high-risk customers
Improving the process to monitor and detect customers in distress
Implementing additional training for collectors
Increasing the number of collection staff
Adjusting the timing of outsourcing accounts to collection agencies after they become past due
For accounts receivable groups that wish to track their level of bad debt write-offs in an effort to improve their own performance, an alternative measure to consider is "bad debt write-offs as a percentage of total receivables," (i.e., bad debt expense/total receivables).
Measuring bad debt as a percentage of receivables (which are within its control, as opposed to sales, which are not within its control) lets an accounts receivable group track its performance more closely.
For other key performance indicators, check out the Benchmarking Tools area on KnowledgeLeader.
While you’re there, click on the Topics tab to see the range of related business process tools, templates and articles, like Accounting/Finance, Accounts Payable & Purchasing, Cash & Treasury, Closing the Books, and Financial Reporting.