In this article, we’ll explain what the collection effectiveness index (CEI) is, how to calculate and interpret it, and offer five tactical steps designed to help you improve your CEI.
The collection effectiveness index (CEI) is commonly referenced in accounts receivable (AR). It’s a critical metric that offers insight into your company's ability to collect on its receivables.
A higher CEI can indicate that your credit and collections teams are doing their jobs well, while a lower CEI may indicate there's a problem that needs correcting.
In this blog, we’ll cover:
What is the collection effectiveness index?
The collection effectiveness index refers to the percentage of its receivables a company has collected during any specific period.
Examining your CEI output can help you determine whether there are any snags in your invoice to cash process that are preventing you from receiving timely payments. For instance, this could be because of manual invoicing processes, a need for more flexible payment terms, or challenges communicating with customers.
CEI may sound similar to another metric you’re likely familiar with—days sales outstanding (DSO)—but there are significant differences between the two:
How to calculate CEI
To calculate your collection effectiveness index, you’ll first need to gather several figures, all for the same time period. These will be:
- Beginning receivables (the amount in outstanding AR at the beginning of the time period)
- Ending total receivables (the amount in outstanding AR at the end of the time period)
- Ending current receivables (the total of all payments received for credit sales made during the time period)
- Credit sales during the time period (the total amount of sales made on credit during the time period)
Once you’ve gathered that information, here is the formula you’ll use to determine your collection effectiveness index.
To illustrate this, let’s imagine your company has the following values for a given month:
- Beginning AR balance – $120,000
- Ending total AR balance – $65,000
- Ending current AR balance – $6,000
- Monthly credit sales – $30,000
Those numbers would plug into our equation like this:
What is a good CEI ratio?
Ideally, you want a collection effectiveness index as close to 100% as possible, though achieving this is not realistic in most situations. Generally, you want to aim for a CEI within the range of 80–90%. A CEI of 59% like the one in the example above may indicate some problems in your AR processes that need to be addressed.
How to interpret collection effectiveness index
If you calculate your CEI and find it to be low, what does this mean for your business? There are various factors that could be contributing to low collection efficiency, including but not limited to:
- Credit or payment terms that are too lenient
- Problems with invoicing processes, including an abundance of manual errors or delays in issuing invoices
- Limited payment options for customers
- Communication challenges between your AR team and your customers
When you’re focused on improving your collection effectiveness index, it’s good practice to thoroughly examine your entire AR process to unearth where the root problems may lie.
What AR teams can do to improve CEI
There are many ways in which a business can improve their collection effectiveness index. And often the solutions are specific to your company’s individual situation. There are, however, several tactical optimizations that every AR team should consider.
1. Automate your invoice delivery
If preparing and delivering invoices to your customers is a very manual activity for your team, then this will inevitably create delays for customers' receiving of their invoices and the start of their payment terms.
Consider automating as much of your invoicing process as possible to avoid these delays. With AR automation software that integrates with your enterprise resource planning (ERP) or financial management system, you can set up automatic delivery of your invoices to customers’ email (or whatever format they prefer).
2. Shore up your credit and payment policies
If your credit policies are too lenient, it can minimize the effectiveness of your collection efforts. You may need to tighten up your lending practices and offer lower credit limits to accounts that could be considered risky. You could also consider shortening your payment terms, for instance lowering net 60 terms to net 45 terms. By tightening up these policies, you’ll make collections easier on your AR team, and hopefully, weed out a significant amount of bad debt.
3. Offer a variety of payment options
If checks are the default payment method you accept, then it’s likely not the most convenient method of payment for your customers. With the shift to remote work, among other factors, many business buyers have reduced their reliance of paper checks in favor of digital payments.
By giving customers the option to pay in the way that best suits their needs—whether that’s by credit or debit card, ACH, virtual card, or, yes, checks—you’re far more likely to receive payments in a timely manner. Having the technology to readily accept and reconcile all these payment methods helps you ensure customers have a positive payment experience.
4. Prioritize customer communication
Overdue receivables are often a result of invoice disputes. These disputes might arise because customers are requesting a correction on their invoice or are denying payment due to damaged goods.
The methods AR teams traditionally use to communicate with their customers (email and phone, according to 86% of business and finance leaders) make it very difficult to resolve these disputes as context can be lost or the right person isn’t looped in.
Collaborative AR (where you can communicate with customers through a shared cloud-based portal) takes these challenges out of the equation. In this case, both buyers and suppliers are able to comment directly on invoices to resolve any issues.
5. Implement strong collections processes around delinquent accounts
Past-due invoices are one of the main contributors to a low CEI. Your collections process runs much more effectively when you can easily identify and prevent delinquent accounts.
Target customers before they become delinquent with automated notifications and reminders, and follow up quickly on invoices that become past-due. Intelligent collections software can make it easy for your team to identify customers who are at risk of paying late and prioritize their outreach accordingly.
Simplify your reporting with AR automation
If your business hasn’t been measuring and tracking collection effectiveness index, you may be missing critical insights into your AR processes.
Without any way to automate accounts receivable reporting, pulling these numbers on a regular basis can be a tedious exercise. When evaluating AR automation software, look for a platform with robust reporting capabilities, so you can take as much of the burden off your team as possible.
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