Tag Archives | credit sales

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.

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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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Raise Inventory Turnover Ratio

Raise or Increase Inventory Turnover Ratio

In order to increase inventory turnover ratio for a company, it is important to understand the calculations that go into calculating the turnover ratio. Once this is achieved, a company can go about the necessary efforts to raise this ratio, increasing the overall inventory sold.

Inventory Ratio Calculation

Inventory turnover ratio calculations may appear intimidating at first but are fairly easy once a person understands the key concepts of inventory turnover.

For example, assume annual credit sales are $10,000, and inventory is $5,000. The inventory turnover is: 10,000 / 5,000 = 2 times

For example, assume cost of goods sold during the period is $10,000 and average inventory is $5,000. Inventory turnover ratio: 10,000 / 5,000 = 2 times

This means that there would be 2 inventory turns per year. That is a company would take 6 months to sell and replace all inventories.

Inventory Turnover Ratio: Example

For example, Derek owns a retail clothing store which sells the best designer attire. Derek, an avid fan of fashion, has worked in the apparel industry for quite a while and is well suited for the operations of his company.

Still, Derek has a little to learn about the business of retail clothing. He has been studying the subject with passion and wants to grow his business. From his study he has realized that inventory turnover is the key to his business.

Derek first talks to his accountant for inventory turnover ratio analysis. This requires somewhat of an expert because the matter is more complicated than the abilities simple, web-based inventory turnover ratio calculator. His accountant comes up with a figure which Derek would like to increase.

Annual credit sales are $10,000 and inventory is $5,000

The inventory turnover is: 10,000 / 5,000 = 2 times

Derek decides, from this, that he needs to make some changes. He aligns a few strategies to move his products. First, he considers marking-down styles from the previous season as each season approaches. Similarly, he considers product give-aways with minimum transaction amounts. Derek considers the option of spreading contests and deals on social networking websites. He finishes his evaluation by finding ways to turn his extra inventory into a tax write-off.

Derek is pleased because he is applying his newly found skills and knowledge to better his business. Derek looks forward to the future.

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increase inventory turnover ratio

See Also:
Inventory Turnover Ratio Analysis

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Net 30 Credit Terms

See Also:
How Important is Personal Credit in Negotiating a Commercial Loan
How to Improve Your Credit Score
Letter of Credit
Line of Credit (Bank Line)
How to collect accounts receivable

Net 30 Definition

What is 2% 10 net 30? Or 1% 10 net 30? The credit terms 2% 10 net 30 means the customer gets a 2% discount if the bill is paid within 10 days. Otherwise, the full amount of the bill is due in 30 days. Net 30 credit terms represent incentive discounts that suppliers offer to encourage buyers to pay promptly. When a product is sold on credit, the supplier delivers the product to the buyer and the buyer agrees to pay for it later. Additionally, net 30 credit terms means 30 days before a penalty for late payment is accrued. It is a mainstay in business to business sales.

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Net 30 Credit Terms Explanation

For those who have just heard about net 30, explanations are needed to understand why it is so commonly used. Net 30 payment terms, with a discount for early payment, induce the buyer to pay earlier. According to the net 30 definition, the total amount of the bill is due in thirty days, but if the buyer pays earlier, the buyer will get a discount of 1% or 2% of the bill, depending on the net 30 payment terms.

Credit Sales

To understand 2 percent 10 net 30 payment terms requires an initial understanding of credit sales. Sales made on credit are essentially like offering an interest-free loan to the customer. In this sense, it represents a cost to the seller and motivates the seller to try to collect receivables as soon as possible. It also represents a benefit to the customer, who is motivated to postpone payment as long as possible. When a customer can hold onto cash it owes to a supplier, the customer is benefiting from an interest-free loan from the supplier via the credit sale. Net 30 vendors bridge the gap between the benefits of trade credit and the disadvantages of slow AR turnover.

Average Collection Period

The average length of time it takes a company to collect payment for credit sales from customers is called the average collection period. A shorter collection period shows a company that is able to collect its receivables quicker and thereby reduce the implied cost or opportunity cost of the interest-free loan to the customer. On the other hand, a company that has a comparatively long average collection period is clearly having trouble collecting payments from customers and this could be a sign of inefficient operations. 2% 10 net 30 days can be one of the many solutions to alleviate this problem.

Net 30 Credit Terms Calculation

For net 30, calculators are not necessary when you understand how the system works. If the buyer decides not to take advantage of the 2% discount by paying within ten days, the buyer is essentially paying 2% interest for the benefit of holding onto the cash for 20 more days. When considered in this way, the buyer’s cost of foregoing the discount amounts to about 36.5% per year. This is because the buyer is essentially paying 2% interest on a 20 day loan; there are 18.25 twenty-day periods in a year; so 18.25 multiplied by 2% equals 36.5% per year (36.5% = 2% x (365/20) . Likewise, by foregoing the 1% discount offered for payment within 10 days is costing the buyer 18.25% per year.

36.5% = 2% x (365/20)

18.25% =1% x (365/20)

So, even if the customer doesn’t have the cash on hand to pay the bill within the 10 day window, as long as the customer can obtain cash for a borrowing cost less than 36.5% (for a 2% discount) or 18.25% (for a 1% discount), that customer would be better off borrowing the money to pay the bill early so as to benefit from the discount offered by the credit terms.

Net 30 Credit Terms: Example

When thinking about the 2% 10 net 30 meaning, an example provides perspective into the idea. Let’s say a manufacturer sells widgets to a retailer for $1,000 and the manufacturer offers the retailer credit terms 2% 10 net 30. The retailer can get a 2% discount on the total bill if it is paid within ten days. In this case, the total net 30 invoice, after the discount, would be $980 and the retailer would save $20.

$980 = $1,000 – (2% x $1,000)

If the retailer foregoes the discount, the full amount of $1,000 will be due at the end of the thirty day period. In this case, the retailer essentially paid (or gave up) $20 in order to postpone payment for 20 days. Hypothetically speaking, if the retailer were to pay $20 dollars in order to postpone payment for every 20 day period in a year, then that would amount to a total yearly cost of $365 ($365 = $20 x (365/20)). Under most circumstances, when offered credit terms 2% 10 net 30, it is in the customer’s best interest to take advantage of the discount and to pay early. Net 30 accounts provide benefit to both the vendor and client.

For more ways to add value to your company, download your free A/R Checklist to see how simple changes in your A/R process can free up a significant amount of cash.

Net 30 Credit Terms

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Daily Sales Outstanding Formula

See Also:
Daily Sales Outstanding (DSO)
Daily Sales Outstanding Calculation
Problem With Days Sales Outstanding Example
CEI vs DSO
Days Inventory Outstanding
Operating Cycle Analysis
Days Payable Outstanding
Unlock Cash in Your Business

Daily Sales Outstanding Formula

The DSO formula is the basic way to calculate daily sales outstanding. In application a very valuable performance indicator becomes evident. Use the following DSO formula below:

Daily Sales Outstanding = 365 X (Average Accounts Receivable / Total Credit Sales)

The formula is derived from an understanding that a company’s success is measured by returns. More specifically, it refers to the notion that the more receivables are collected, the better off a company is faring. The “365” refers to the number of days contained in the recording period. If you calculate an overall estimate of Daily Sales Outstanding for the year, utilize 365 as an appropriate figure; representing the 365 days in the year.

Accounts Receivable Explanation

The average accounts receivable is fairly straight forward. This figure represents the overall amount that a company is owed. As the receivables goes up, that means that the company is making more sales overall. More clients owe the company money and therefore the net worth is increasing. At the same time, however, if receivables continues to increase, that means that the company has money that it has not collected yet (outstanding dues). The final important aspect of this formula is the total number of sales. The total number of credit sales refers to the total number of sales made as a whole. It makes sense for this number to be the denominator of this formula because of the fact that the total number of sales acts as a success indicator as a whole.

DSO & Accounts Receivable

At the end of the day, as the Daily Sales Outstanding formula yields lower figures, the organization continues to collect the money owed to them. This is what makes the recording period so important. When introducing the number of days in the recording period into the equation, translate the overall success of the company into the timeline of the collecting period. Using the Daily Sales Outstanding formula, the company can determine the outstanding balance of returns that they are owed on a daily basis.

Additionally, you can compute the Daily Sales Outstanding formula in two very similar ways. The first method is the one that is listed above, using the average accounts receivable. The other method takes the overall accounts receivable instead of the average. Many companies use the average accounts receivable because it gives a more accurate picture of the company’s performance.

If you want to reduce your DSO, download our free A/R Checklist to see how simple changes in your A/R process can free up a significant amount of cash.

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Daily Sales Outstanding Calculation

See Also:
DSO – Daily Sales Outstanding
Daily Sales Outstanding Formula

Daily Sales Outstanding Calculation

The daily sales outstanding calculation requires little more than a basic understanding of mathematics. Maintaining proper financials allows this and other essential calculations to be performed. The days sales outstanding formula, ultimately, leads to monitoring the health and wealth of your business. As a whole, perform the calculation of Daily Sales Outstanding using different periods of time as the overall indicator. Whether it be by years, months, or days, the organization as a whole needs to decide which method of time is the most appropriate for successful figures and for impressions. This is important because the different time periods can portray different results in cash flows and statistical models.

Calculating Daily Outstanding Sales is fairly simple, as said before. First, divide the total (or average depending on if you need actual or average days) accounts receivable balance by the total credit sales. Then multiply this remaining number by the total number of days or months in the time period. This also depends upon whether you desire average or total days. See the following example below.

Example of Daily Sales Outstanding Calculation

For example, assume Total Credit Sales are $1,000,000 and Average Accounts Receivable is $100,000.

(DSO) Days Sales Outstanding Calculation: 365 X (100,000 / 1,000,000) = 36.5 days

This is a simplified explanation of how to calculate daily sales outstanding. What the days represent is essentially the average number of days that are needed in order to collect the total accounts receivable balance from clients. A trained CFO can provide more extensive analysis and solutions. At the same time, it would not be overly difficult to produce the same quality work as a trained CFO.

After you complete the calculation, match the figures against the competition in the industry. Then determine the overall health of the organization. As far as the final figures go, calculating the Daily Outstanding Sales can tell you a couple of things about the state of your business. If the credit sales are substantially higher than is customary, then your services are being handed out much like a loan. The customers are purchasing this service without paying. A consequence of this could be a negative effect on a company’s cash flows so extensive credit sales should be avoided without collection.

Download the A/R Checklist to see how simple changes in your A/R process can free up a significant amount of cash.

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Credit Sales

See Also:
Trade Credit
5 Cs of Credit
Collateralized Debt Obligations
Cash Flow Statement
Balance Sheet

Credit Sales Definition

In accounting, credit sales refer to sales that involve extending credit to the customer. The customer takes the product now and agrees to pay for it later. Credit sales are a type of trade credit. They create receivables, or moneys owed to the company from customers.

Credit sales terms often require payment within one month of the invoice date, but may also be for longer periods. Many companies offer discounts for early payment of receivables. For many companies, all of their sales are credit sales. Most of the commercial transactions between businesses involve trade credit. Trade credit facilitates business to business transactions and is a vital component of any commercial industry.

Sales made on credit are essentially like offering an interest-free loan to the customer. It represents a cost to the seller and motivates the seller to collect receivables quickly.


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Credit Sales and Average Collection Period

The average length of time it takes a company to collect payment for credit sales from customers is called the average collection period. A shorter collection period shows a company that is able to collect its receivables quicker. In addition, it shows they reduced the implied cost or opportunity cost of the interest-free loan to the customer.

On the other hand, a company that has a comparatively long average collection period is clearly having trouble collecting payments from customers and this could be a sign of inefficient operations.

Credit Sales Example

For example, if a widget company sells its widgets to a customer on credit and that customer agrees to pay in a month, then the widget company is essentially extending an interest-free loan to the customer equal to the amount of the cost of the purchase.

As long as the customer puts off paying for the purchase, the widget company is paying interest on loans that are tied up in the accounts receivable account due to the sale that was made on credit. In this sense, the widget company is paying interest on the customer’s loan.

The widget maker would be better off trying to get the customer to pay as soon as possible. To do so, the widget company may offer a discount to the purchase price for early payment. For example, the widget company may offer its customers a deal like 2% ten, net thirty. This deal states that the customer gets a 2% discount if they pay within ten days, otherwise they pay the full amount in thirty days. The 2% discount, when calculated out as yearly savings, turns out to be quite a substantial discount and a powerful incentive for the customer to pay early.

credit sales

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