What is the Collection Effectiveness Index?
The collection effectiveness index (CEI) is used to measure the ability of the collections staff to collect funds from customers. This measurement shows how much was collected from the pool of all available accounts receivables, thus indicating if the collections team is achieving a high rate (over 80%) or if there is cause for further investigation into collections practices.
The CEI figure can be calculated for a period of any duration, and is typically done monthly. To calculate your CEI, you need a few numbers handy:
Beginning receivables is your open receivables at the start of the month. It also happens to be the ending total receivables from the previous month. For example, if your ending total receivables was $10 million on March 31, the beginning receivables for April 1 would also be $10 million.
Monthly credit sales is the sales made by extending credit in that month.
Ending total receivables is all of the open receivables including current and overdue receivables at the end of the month.
Ending current receivables are strictly the open receivables that are not overdue.
The formula for the CEI is:
(Beginning receivables + Monthly credit sales) - Ending total receivables
(Beginning receivables + Monthly credit sales) - Ending current receivables)
So in real numbers, your calculation might look like:
Beginning receivables: $25M
Monthly credit sales: $40M
Ending total receivables: $35M
Ending current receivables: $20M
(25M + 30M) - 35M = $20M
(25M + 30M) - 20M = $35M
20M / M35 = .57
.57 x 100 = 57%
CEI = 57%
Why measure CEI?
The result of your CEI calculation can give you actionable information. First, it shows your team’s performance in collecting receivables. This indicates that your collections team has a process that’s working to follow up on receivables and bring money into the business.
It also shows how quickly accounts receivables turn into closed accounts.
This window of time speaks to the strength of your collections process as well as to the health of your customers, who are able to address their bills in a timely fashion. Knowing how well your customers are responding to the actions of your collections team helps you keep on top of your forecasting, as well as your customer relationships.
Understanding this number and calculating it on a regular basis will also tell you when things change within your collections team or their procedures. An decrease in your CEI, for example, could indicate that a process is breaking down and requires improvement. Or conversely, the introduction of a new process could show benefits in closing open AR faster, and now you have a sense of the ROI for your new process.
What about DSO?
Day Sales Outstanding (DSO) is another metric used to track the health and effectiveness of your cash flow. Some businesses use both DSO and CEI in tandem to get a fuller picture of their AR team’s performance and their cash flow health.
DSO provides a snapshot into how long it takes your business to get paid, providing a sense of the health of your cash flow when tracked over time. This information tells you if you need to adjust credit or collections policies, or if the economy is having an impact on your working capital.
CEI looks specifically at the effectiveness of your collections department and tracking that your business is getting paid for its goods and/ or services. By regularly calculating CEI, you get a clear view into whether specific collections processes are working or require attention.
Finally, using both CEI and DSO will provide you with useful insights into your cash flow, helping you to manage your working capital in the most beneficial ways to ensure business growth.