Accounts Receivable (AR) are often an overlooked aspect of a company’s operations, particularly in high-growth organizations. It’s common to invest considerable amounts of energy on top-line metrics such as ARR. However, with an ineffective cash-collection strategy a portion of that ARR can turn into Bad Debt. This not only nullifies part of the Sales & Marketing effort but can also generate cash flow issues.

These 5 KPIs to track AR can provide you quick insights into how well cash collections are managed.

Top 5 KPIs to Track AR

Which KPIs to track will vary depending on the company’s stage. However, there are a few always applicable metrics that help you keep things under control and unveil strategic insights.

1. Days Sales Outstanding

Days Sales Outstanding (DSO) is a KPI that represents the average number of days it takes for customers to pay.

It can be calculated as follows on a monthly basis:

[Total Accounts Receivable / Total Credit Sales] x 30.4

A low DSO means you are collecting fast from your customers. A high DSO means customers are slow to pay. The longer the wait, the more likely you will never see that payment.

Most accounting software will provide a so-called AR Aging Report. This gives you a real-time view of which invoices are past-due, segmenting them by periods.

2. Best Possible DSO

Best Possible DSO is similar to the normal DSO metric, but it only considers the current AR, i.e., it excludes AR which is overdue. This metric is helpful to understand the average number of days it takes customers to pay, assuming they pay on time.

The formula to calculate Best Possible DSO is: 

[Current Accounts Receivable / Total Credit Sales] x 30.4

3. AR Turnover Ratio

This metric is in some ways the inverse of DSO. It tells you the number of times you collect your average AR balance per year. The formula is:

AR Turnover Ratio = Net Credit Sales / Average Accounts Receivable

Inversely to DSO, the greater the ratio, the better your cash flow.

4. Average Days Delinquent (ADD)

This metric helps you inform on how many days your AR remains overdue on average. This is helpful in conjunction with the Best Possible DSO because it focuses on overdue accounts instead of current accounts.

Average Days Delinquent = Days Sales Outstanding – Best Possible Days Outstanding

5. Bad Debts to Sales

This is our fifth and last key metric. Bad Debt comprises AR you don’t expect to collect. This ratio shows the percentage of your revenue that turns into bad debts.

Bad Debts to Sales = Uncollectible Receivables / Total Sales

Unfortunately, Bad Debt is a natural part of every business. This is why most companies have a Bad Debt provision. But of course, you want to minimize it as much as possible.

Benefits of a Successful AR Strategy

1. Better Cash Flow. A low DSO implies you collect the revenue your customers owe you faster. This helps keep the Cash balance higher, which can be redeployed or kept for safety
2. Efficient Working Capital. Keeping track of your AR metrics helps minimize the balance and act fast, particularly for overdue invoices
3. Minimize Bad Debt. Understanding ADD and acting upon it can decrease Bad Debt
4. Payment Terms. Strategic insights into AR can help you strike a balance between loose terms that boost sales and strict terms that lead to finance efficiency

Not All Customers Are Equal

Once you are on top of your core AR metrics, you can get more sophisticated. Often averages hide the significant difference in customer segments, products, or markets. It helps to restrict the context of your AR metrics segmenting them. For example looking at Enterprise vs SMB customer segments, or Annual Plans vs Monthly Plans.

This will further increase your intelligence in crafting successful initiatives to increase your cash-collection effectiveness.