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Maximizing Your Bottom Line In 3 Simple Steps

Sales are great, but wouldn’t they be better if you were actually able to reap the rewards? Many CEOs that were not trained with an accounting/finance background struggle to understand profitability. They think that if sales are great, then the business is great. But when sales increase, inventory and overhead increases. Productivity also decreases – due to exhaustion or overwork. Collections lapse because there isn’t a “pressure” to collect. And unfortunately, that is when companies suffer the most. Sales start to decline, but they don’t change their habits. In this Wiki, you will learn how everything below sales on your income statement is critical to your company’s success and how you should be maximizing your bottom line – net income – at any stage of your company’s life cycle. Let’s look at how maximizing your bottom line in 3 simple steps can happen.

What is the Bottom Line?

First, what is the bottom line we are referring to? It is the net income on your income statement or P&L statement. This is what you have left after all the costs of goods sold, administrative expenses, and overhead have been subtracted from revenue. We look at this number carefully because that is how much you are able to put into retained earnings or reinvest back into your company. In addition, the amount can be used to issue dividends to their shareholders. Maximizing your bottom line should be an integral part of your company’s processes.

Profitability starts at the top of the income statement. If your prices are not set to create profitable environment, then you will be not able to maximize the bottom line. Learn how to price for profit using our Pricing for Profit Inspection Guide.

Maximizing Your Bottom Line In 4 Simple Steps

There a are several ways to maximize your bottom line – some more extensive and time consuming than other. But there are 3 areas to focus on to maximize your bottom line – including productivity, overhead, and collections.

1. Productivity is Key

It’s been a common theme among business blogs and news sources (Entrepreneur, Forbes, WSJ, etc.) to improve productivity. Why? Because productivity is key in maximizing your bottom line. But what really happens when you improve productivity? You have more supply, decrease the cost to produce 1 unit, and increase sales. It speeds up your operations so that you can fulfill more orders for quickly.

2. Manage Overhead

Great revenues have very little meaning if your overhead costs are not properly managed. Look deeper into your overhead expenses and find out if there are any costs you can reduce or completely remove. The problem is often more complex than large expense accounts on the P&L. You must interact with various departments to think critically and solve problems. Ensure that every single overhead cost is necessary to provide the desired service levels. Maximum controllability over costs leads to higher profits for the company to reap.

3. Collect Quicker

Collections are an important part of business. If a company sells $10,000 worth of product but only collects $3,000, then their cash is tied up in inventory, etc. As a result, they experience a cash crunch. We have worked with clients who were in the same situation and they neglected to ever collect the outstanding balance. Their bottom line suffered, but they didn’t think to look at their collections process. There are two metrics that you can look at to monitor collections and use to collect quicker.

The first metric is DSO. Do you know your Days Sales Outstanding (DSO)? This is a great measurement to know where you are currently and how by making slight adjustments, you can increase profitability. Use the following formula to calculate DSO.

 DSO = (Accounts Receivable / Total Credit Sales) * 365

The second metric to look at is Collections Effectiveness Index (CEI). This is a slightly more accurate representation of the time it takes to collect receivables than DSO. Because CEI can be calculated more frequently than DSO, it can be a key performance indicator (KPI) that you track in your company. If the CEI percentage decreases one month, then leadership are alerted that something is going on. The goal here is to be at 100%.

CEI = [(Beginning Receivables + Monthly Credit Sales – Ending Total Receivables) ÷ (Beginning Receivables + Monthly Credit Sales – Ending Current Receivables)] * 100

Another method to collect quicker is to tie receivables to the sales person’s commission. This will not only encourage your sales team to be part of the collections process, but it will help keep your company cash positive.

Effective Strategies for Improving Profitability

While we’ve been focused on maximizing your bottom line as your current financials stand, we also wanted to share some effective strategies for improving profitability.

Price for Profit

Are your prices leading to a satisfying net income?  If not, then these are some questions you can inquire:

  • Are additional costs being reflected on the price?
  • Are you using Margin vs Markup interchangeably?
  • Is your overhead being covered?

The solution might be simple: Adjust your price!

Learn how to price for profit using our Pricing for Profit Inspection Guide. This whitepaper will help you identify if you have a pricing problems and how to fix it.

Create Standard Operating Procedures (SOP)

Also, create Standard Operating Procedures (SOP). SOPs are step by step instructions written by a company to assist employees in completing routine procedures. They are necessary in a company to ensure operations run smoothly. The better your company’s SOPs are, the more efficient it will run. Create operating procedures that are simple, easy to read, and most importantly make them lead to a purpose.

Focus on Profitable Customers

Identifying profitable customers is instrumental to a company’s success. Once you completely identify your most profitable group of customers, focus your attention on them. Use your marketing funds primarily on you most profitable customers. A customer outside of that target market is still a viable customer, but they just shouldn’t receive as much marketing attention since they are not their primary and most profitable customer segment.

When maximizing your bottom line, start with your prices and pricing process. Access the free Pricing for Profit Inspection Guide to learn how to price profitably.

maximizing your bottom line

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Collection Effectiveness Index (CEI)

See Also:
CEI vs. DSO
Key Performance Indicators (KPI’s)
How Does a CFO Bring Value to a Company?
5 Stages of Business Grief

Collection Effectiveness Index (CEI)

The Collection Effectiveness Index, also known as CEI, is a calculation of a company’s ability to retrieve their accounts receivable from customers. CEI measures the amount collected during a time period to the amount of receivables in the same time period. In comparison, the collection effectiveness index is slightly more accurate than daily sales outstanding (DSO) because of the time period. A company’s CEI can be calculated for any amount of time, small or large. Conversely, DSO is less accurate with shorter time periods, which is why DSO is calculated every 3 to 6 months.

The Collection Effectiveness Index Formula

Collection Effectiveness Index

The formula consists of the sum of beginning receivables and monthly credit sales, less ending total receivables. Then, divide that by the sum of beginning receivables and monthly credit sales, less ending current receivables. The value is then multiplied by 100 to get a percentage, and if a CEI percentage is close to or equals to 100%, then that means that the collection of accounts receivables from customers was most effective.

(Are you look for more ways to improve your cash flow? Click here for the free complete checklist guide to improve your cash flow!)

CEI and Your Business

The collection effectiveness index is one of the most useful tools a company can use to monitor the business financials. It measures the speed of converting accounts receivables to closed accounts, which then indicates new methods or procedures one can use to retrieve accounts receivables even more. If the CEI percentage decreases, then that’s a key performance indicator that the company needs to put in place in policies or investigate the departments in more detail.

How to Increase a Company’s CEI

Among other ways to reduce accounts receivable, the collection effectiveness index alerts when and how to change the process of retrieving those accounts. By monitoring cash in a company more frequently, financial leaders will notice a pattern and are more inclined to make a change quicker. Changing your policy from checking 3 times a year to 6 or 8 times a year, and the results that come from it, will show a substantial difference in a company.

Collection Effectiveness Index

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Collection Effectiveness Index

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CEI vs DSO

Cash is king. CEI vs DSO, Collection ManagementA company must have a positive cash flow to stay afloat. Particularly in an economic downturn, our clients struggle to maintain a positive cash flow when sales are down. Fortunately, there are several metrics that you can use to monitor and improve your cash flow.

One of the conversations we’ve begun to hear lately is focused on which is better: DSO vs CEI.

Days Sales Outstanding (DSO)

Days Sales Outstanding (DSO) is a useful formula to measure the average age of accounts receivable. As a management tool, it can be used to track and improve collections as well as motivate employee performance.

 DSO = (Accounts Receivable / Total Credit Sales) * 365

DSO is not a measurement of effectiveness, rather efficiency. For example, ABC Company has a DSO of 45 days. That means that it takes 45 days from the delivery of service to the delivery of payment. Let’s assume ABC Company sold 60% of their inventory with a DSO of 45 days, but their payments for the inventory are made in 30 days.  See any problems? ABC Company doesn’t have cash to pay for its inventory because it’s tied up in receivables!

One problem with DSO is that it isn’t always smooth. Cyclical businesses like water parks or toy stores have their peaks (summer and winter, respectively) throughout the year. Their DSO is going to be different from the high compared to the low.

Another problem is while DSO is a good measure of the revenue-to-cash cycle, it’s not a good measure of collections efficiency.  DSO is dependent upon credit terms, so if your terms are net 30, getting DSO below 30 is not likely to happen.

Need some ideas on how to improve your cash flow?  Download our free tip sheet 25 Ways to Improve Cash Flow.

Collection Effectiveness Index (CEI)

Collection Effectiveness Index (CEI) is used to track accounts receivable, much like DSO.

CEI = [(Beginning Receivables + Month’s Invoice Revenue – End Total Receivables) / (Beginning Receivables + Month’s Invoice Revenue – End Current Receivables)] * 100

The Credit Research Foundation developed CEI to give a more precise reflection of credit and collections performance for companies with fluctuating sales.  It focuses on the effectiveness of collections efforts over time. CEI looks at collections relative to accounts that have come due and not the current receivables that are unlikely to be paid early.

The goal is for CEI to be close to 100%. This shows effective and efficient collections processes. Understanding and tracking CEI is important not only to monitor the creditworthiness of your customers, but to ensure adherence to established collections policies.

Purpose of Measuring CEI vs DSO: Collection Management

Now that we have the basics out of the way, what is the purpose of measuring CEI and/or DSO?

The shorter the DSO, the faster a company gets cash to fuel operations. The higher the CEI percentage is, the tighter the collections process is. Either way, it’s all about accounts receivable!

There are a couple of important reasons to measure CEI and DSO:

Should I change from DSO to CEI?

CEI

It depends. Many use DSO widely because it is easy to benchmark.  It can be a powerful KPI, especially for businesses that don’t experience spikes or drops in sales.

CEI might be a better indicator for businesses that experience cyclical sales.  Because it looks at collections efficiency over the period calculated, it doesn’t matter if sales are up or down for the period.  It just measures how much of collectible sales were collected.

Why not use both?!  DSO dips and spikes can alert you not only to collections issues, but sales issues as well.  CEI helps you make sure that whatever your sales volume, cash is getting in the door as quickly as possible.

For other ways to improve your cash flow, download our FREE white paper with 25 ways to improve cash flow by clicking here or the image below.

CEI vs DSO, Collection Management

Strategic CFO Lab Member Extra

Access your Strategic Pricing Model Execution Plan in SCFO Lab. The step-by-step plan to set your prices to maximize profits.

Click here to access your Execution Plan. Not a Lab Member?

Click here to learn more about SCFO Labs

CEI vs DSO, Collection Management

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Examples of DSO

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