Tag Archives | DSO

Adding Value as a Financial Leader

Adding Value as a Financial LeaderThe role of the CFO or financial leader of an organization used to be termed as a “numbers cruncher”. For many reasons, The Strategic CFO has been working tirelessly to coach, consult, and mentor CFOs, Controllers, and others in the finance and accounting function to go from being a number crunchers to a value-adding financial leader. In addition, the role has naturally evolved to go beyond finance. McKinsey reports that 41% of the CFO’s role isn’t even in finance and accounting. As a result, adding value as a financial leader has dramatically changed.

Adding value as a financial leader goes beyond accounting and finance. The CEO needs a wingman – someone to guide them, provide strategy, and back up with a financial plan. To learn how to be a wingman, click here to access our How to be a Wingman guide.

Adding Value as a Financial Leader

We define “value”, in regards to adding value as a financial leader. But, how does one add value? They are a steward of both financial and non-financial performance. They are also responsible for partnering with other business, supporting business strategy, and sustaining value-adding strategies. In other words, adding value as a financial leader simply means supporting the organization (specifically the CEO) to do what they do best – cast the vision for the company.

Value-Adding Financial Function

In order for the finance function to be value-adding, the function (AKA the CFO) needs to have buy-in from the organization’s leadership. This buy-in allows that financial leader to oversee HR, IT, tax, finance and accounting. The finance and accounting function must support these departments or areas of business in order for it to be value-adding.

If the CFO of an organization is what we call a CFnO, then nothing will ever get done and no value will come out of that role. However, if the CFO provides data and analysis to allow the CEO to take a calculated risk, then that role will be value-adding

The Changing Role of the CFO

With technology advancements, more regulations, and additional complexity, the role of a CFO is completely different from 20 years ago… Even 5 years ago.

How Does a CFO Add Value?

Adding Value as a Financial LeaderThe three legs of an organization include sales, operations, and accounting. If one of those legs is falling short or is more successful than the other leg, then the stool risks tipping over. How does a CFO add value? A CFO adds value by understanding on each of those legs equally.

A financial leader or wingman needs to go beyond the accounting and finance function. To learn how to be a wingman, download our How to be a Wingman guide.
  A good CFO truly understands the operations side of the business.

Convert Accounting From a Cost Center to a Profit Center

Accounting is often seen as a cost center. That’s not a new thought or revelation. But the accounting department has the opportunity to convert itself from a cost center to a profit center under the direction of the right financial leader. How do you make this change? You focus on your margins, working capital and cash flow. As an accounting department, you do not have the ability to make sales. However, you do have the ability to identify waste, or better ways of buying insurance, or signing leases, reduce overhead, increase profit margins, and work to bring more down to the bottom line. In a McKinsey Special Collection, they outline that,

Valuing such initiatives often requires nuanced thinking. Although some transformations include radical changes, most create significant improvements on the margin of existing operations. That requires an understanding of the organization’s marginal economics—that is, the costs and benefits of producing one additional unit of product or service. When managers have a clear understanding of the marginal value of improving each of the activities that contribute to performance, they have the potential to redirect an entire transformation.

Streamlining Operations

Look at efficiencies in the operation. Understand the measure of throughput if you manufacture something, look at labor hours and efficiency if you provide services. Your monthly dashboards as CFO should include accounting and financial measures, but also operations metrics.

Customer Service

Working to respond to customers quicker and with more satisfactory answers should be a priority of the company. One indicator that I manage in my business is customer turnover. It’s much easier to keep a customer than it is to find a new customer. Therefore, streamline your customer service processes. This can include getting more responsive tracking software, hiring better or more representatives, training every employee to respond to customers.

Days Sales Outstanding (DSO)

It is common to have a collections department if you are a larger organization. But if you are smaller the collections effort often lies with the sales people who have the relationship with the customer, and sometimes the collections effort is done by someone in accounting.  It really should be the person with the client relationship.  Either way, make sure someone is following up with collections.  You would be surprised how many times I have walked into a business and one side of the business thinks the other is following up on collections, when in reality no one is.

Want to get more tools that can help you become more profitable, streamline operations, and collect A/R quicker? You can access that and so much more in the SCFO Lab. Click here to learn more. 

Be the trusted advisor your CEO needs and access the How to be a Wingman guide.

Adding Value as a Financial Leader

Strategic CFO Lab Member Extra

Access your Projections Execution Plan in SCFO Lab. The step-by-step plan to get ahead of your cash flow.

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

Click here to learn more about SCFO Labs

Adding Value as a Financial Leader

1

Black Friday

In America, Black Friday is an event that is not only the most shopped on day during a typical year, but it also generates huge sales.

“Only in America do people trample others for sales exactly one day after being thankful for what they already have.”

~Author Unknown

Black Friday Definition

The Black Friday definition is a retail store sale that occurs the Friday after Thanksgiving – an American holiday in November. Many consider this event to be the kick-off to the Christmas shopping season. Many retailers, such as Walmart, Kohls, Kmart, Macy’s, Express, and other major retailers, open their stores in the early hours of the morning to receive the first rush of customers. Door busters, sales, huge discounts, and giveaways are all part of this event.

The History Of Black Friday

Black Friday originated in 1952 as the start of the Christmas shopping season. Because many states in the United States considered the day after Thanksgiving to be a holiday as well, retail shops realized that there were enormous amounts of potential shoppers available during this four-day weekend. But since 2005, this event has launched into record numbers for sales, shoppers, etc. For example, sales dropped for the first time since the 2008 recession in 2014. Yet, sales boasted $50.9 billion over that weekend.

Although not all states in the United States permit workers to work on national holidays or even the day after Thanksgiving, companies have broken many boundaries to take advantage of this rush of customers. Over time, retail stores and e-commerce platforms have expanded on Black Friday to include Cyber Monday. It’s become a tradition to many.

Cyber Monday

Because Black Friday became such a hit, online companies created another shopping event – Cyber Monday. It occurs the Monday after Thanksgiving and encourages shoppers to purchase more gifts and things on Monday. Originally, it was launched in 2005.

The Cost of Black Friday

While it may be tempting to join in on Black Friday specials and sales, you have to consider the cost. Remember, a sale isn’t necessarily a good sale. It has to be a profitable sale.

Some of the costs associated with Black Friday include.

How to Win on Black Friday

In order to win on Black Friday, you have to price your products for profit. Especially since you project to sell large quantities of product, you need to make sure you don’t start with a pricing problem. If you cut prices off a product that is already not profitable, then you will loose more potential profit. Before you start planning for Black Friday, make sure your pricing is in check. Click here to download our Pricing for Profit Inspection Guide.

Price for Profit During These Sales

Each sale you make has to return a profit. Therefore, you need to allocate as many costs to each good to make it easier. How much inventory do you need to push in order to turn a profit? But also, what prices are customers willing to spend? The trick with Black Friday is that since everyone is competing for the best deal, you must know what others are pricing the same product at.

Reduce DSO by Turning Over Inventory

The risk for big sales like Black Friday is that there will be some that cancel their credit card transaction for $1,800 worth of product. Because you are putting a lot of cash up front to increase inventory, you need to collect cash as quickly as possible. For example, you can offer discounts for cash only. For other pricing tips, download the free Pricing for Profit Inspection Guide to learn how to price profitably.

Black Friday

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

Black Friday

0

Turnover in Collections is Destroying Your DSO

One of our clients called us up because his DSO went from 34 days to over 72 days within a couple months. He couldn’t figure out what was causing his daily sales outstanding (DSO) to increase so dramatically in such a short time. When we came in the office to investigate, we found that there was significant turnover in the A/R and A/P staff. As a result, collections were not being consistently collected on. Turnover in collections is destroying your DSO. But how does turnover impact your DSO?

Turnover in Collections is Destroying Your DSO

What happens when there is high turnover in a company? Decreased productivity, bad communication, reduced training, lost processes, and so much more. When we started working with our client mentioned above, they were turning over A/R personnel very quickly. At first, the management didn’t think about their DSO. Sales were going great! But no cash was being collected. What they originally thought was a cash flow problem became more of a management issue.

How are you managing your cash? After 25+ years of working with clients in cash crunches, we designed the A/R Checklist AND you can access for free here. Enjoy!

maintaining accurate records

What Happens When Turnover Is High The Collections Departments

Think about what happens when turnover is high in the collections department. Communication is not clear on who has been contacted, what to charge, if an invoice has been sent out, etc. It can easily get out of hand if communication is not seamless during the transition. There simply is no continuation and follow up.

You also need to address why turnover is high. Are you firing your employees? Are many employees retiring? Is morale down due to an upcoming transition? Are you not compensating them enough to stay? There is typically a reason for high turnover. But it may take some investigating. Do you have a good idea for what is an acceptable turnover rate?

Consider calculating the transaction turnover per A/R employee. If your number is low, you need to start improving the collections process.

      Number of Transactions Processed      
Number of Accounts Receivable Employees

Collections Cannot Be Automated

There’s a lot of things you can automate, but collections are not one of them. You cannot automate human behavior and nothing can replace a live call or meeting between two parties. While we may see some sort of automation built into this process, we don’t foresee it taking the humans out of this role. For example, if a client needs to explain that they need to extend their payment another week, they need a speak to a person, someone authorized to extend payment terms. Furthermore, if their contact person in A/R keeps changing, then those receivables will not be collected timely.  Management often underestimates the importance of having someone in receivables developing a relationship with the customer.

[HINT: Turnover may be high for a myriad of reasons, but your company still needs cash. Consider offering a discount to the client for paying in a certain number of days. Read more about discounting receivables here.]

 

How to Save Your DSO When Turnover is High

Your DSO is a key indicator for management to look at. But like other indicators, you need to know what impacts those variables and why. Employee turnover in A/R can directly impact DSO as those employees are the people responsible for collecting. When turnover is high, communications and processes don’t always get passed down properly or effectively. Let’s learn how to save your DSO when turnover is high.

Know the Cycle

First, you need to know the cycle. Companies (and economies) going through cycles where cash is tight, turnover is high, and credit becomes tight. .  Look at the recent oil & gas crisis. Oil price hit record highs, companies began to spend more, they took on more debt. Then the price of oil drops, companies find themselves paying for debt service based on a bigger size and larger revenue, cash gets tight.  The bank and other creditors tighten up until things get better down the road.

But if you’re experiencing high turnover that doesn’t reflect what the macro economy is doing, then you need to look internally.

Start by tracking your DSO at regular intervals. Make this part of your normal monthly reporting process.  This will give you a basis to predict cash flow and indicates when things are going south. When you create a DSO trend, it is easier to spot irregularity.

Identify Areas With Low Turnover

What areas in your company have low turnover? Is it sales, operations, upper level management, etc.? Identify the areas with low turnover. Regardless of their role in the company, someone needs to collect the cash or the company will be in trouble. For example, you have 5 sales people that have been there for an average of 15 years. Your A/R department has turned over 5 employees in the last 2 years. Choose one of your sales persons to manage the transition between A/R employees. Your sales people often have the relationship with the customer.

Write Down Your DSO Improvement Strategies

This is probably the most important step to saving your DSO when turnover is high. Write it down! A strategy isn’t a good strategy if you don’t write it down. Have written processes for collections as well as notes of what has been done for the entire accounting department will help everyone know where you are at.

Write the collections process down with all your DSO improvement strategies.

Then, write down notes from client conversations, steps in the collections processes. Have frequent internal meetings about collections.  Assign tasks to individuals and write down the progress or lack of progress.  The CFO should be made aware of collections, DSO and trouble accounts.

Improve Your DSO

Whether you are experiencing high turnover in your A/R staff or not, it’s important to continually improve your DSO. 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.

Turnover in Collections is Destroying Your DSO

Strategic CFO Lab Member Extra

Access your Projections Execution Plan in SCFO Lab. The step-by-step plan to get ahead of your cash flow.

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

Click here to learn more about SCFO Labs

Turnover in Collections is Destroying Your DSO

0

Improving Profitability – Fuel for Growth

How do you focus on improving profitability instead of just boosting sales? 2016 wasn’t the best year for some of us, but the new year provides a perfect opportunity to reassess goals. An entrepreneur’s natural tendency is to increase sales in order to balance out last year’s financials. But what many entrepreneurs fail to consider is are those sales actually profitable?

There’s Only So Much Cash

Why is improving profitability instead of simply increasing sales so important? Because, believe it or not, you can actually grow yourself into bankruptcy.

Huh?

Many are quick to say that more sales is the solution – however, there are a lot of factors you have to consider before you start selling everything. One of the most important metrics you must know is your cash conversion cycle. The cash conversion cycle is the length of time it takes a company to convert resource inputs into cash flows.

Cash Conversion Cycle Formula:

Cash Conversion Cycle (CCC) =Days Sales Outstanding (DSO) + Days Inventory Outstanding (DIO) – Days Payable Outstanding (DPO)

– or –

CCC = DSO + DIO – DPO

improving profitability instead of salesDaily Sales Outstanding (DSO): This metric measures the number of days it takes to convert your receivables into cash. Ideally, the faster you can collect, the faster you can use the cash to fuel growth.

Days Inventory Outstanding (DIO): This is an indicator of how quickly you can turn your inventory into cash. Reducing DIO is good. If all of your cash is tied up in inventory that isn’t moving, then you might have a problem.

Days Payable Outstanding (DPO): This measures how quickly you are paying your vendors. If you are consistently paying your vendors more quickly than you are getting paid by your customers, then you risk running out of cash. If your vendors aren’t giving you a discount for paying early, then why are you paying early? If you have 30 days to pay, then why pay on the second day? Use that cash for the other 28 days you have for other vendors who offer you discounts or to fuel growth.

Managing the cash conversion cycle is a key way you can enable your company to grow.  And we all know how fond entrepreneurs are of growth…

(Click here to learn How to be a Wingman and be the trusted advisor to your team.)

Cash is like Jet Fuel

Often, entrepreneurs (especially those from a sales background) focus on improving sales. What many fail to realize is you can actually sell yourself into bankruptcy.

Let’s compare a business to a jet. If a jet is moving at a constant pace, then the fuel used to power the jet runs out at a constant pace. From a business perspective, if the sales in a company are constant, then the cash and assets required to fuel the company is also constant and predictable.
improving profitability instead of salesHowever, if a company decides to increase sales, then this requires more “fuel” or cash.

But if an entrepreneur decides to increase sales to a greater degree than cash flow, almost vertically, then the business may run out of fuel (cash) and can ultimately crash and burn.
improving profitability instead of sales

The quicker you grow, the quicker you burn cash.

improving profitability instead of sales

Sustainability is Key

The sustainable growth rate of a company is a measure of how much a company can grow based upon its current return on assets. The sustainable growth rate of a company is like the wind turbine of a jet. Naturally, the wind turbine gives the jet a 5-10% incline. But what if you want to grow to 25%? Or 50%?

To grow faster than your return on assets, you’ll need to take on additional debt or seek equity financing. Either you pay for it, or someone else does. To avoid increasing debt or giving up control, it’s important to maximize your current asset velocity (think managing CCC) and make sure your sales are profitable.

(Be more than overhead. Be the wingman to your CEO by increasing cash flow!)

How to Grow Your Business

If you want to grow your business, there are a couple of things you can do:

(1) Increase your profitable sales. This means deciding which projects have the lowest risk, but highest reward for your business. Time is money, so which customers are worth your time? In exploring this, you might have to conduct some market research for your target market.

For example, if you have some customers who are slow to pay, they’re straining your liquidity. Although it may be difficult, you might have to fire some customers and focus your resources on customers that aren’t such a drain.

(2) Increase capital. Capital is the funding you need to grow the business. Capital can be an investment from an outsider, or it can be cash generated internally by increasing cash flows and maximizing profitability.

Internally: A company can increase cash flow by managing the cash conversion cycle. Collect your receivables faster and manage inventory levels and payables. It is a good idea for a company to grow as organically as possible, meaning growing cash internally.

Externally: If you’ve tightened up your CCC as much as possible, it might be necessary to look for outside sources of cash. However, having external sources of cash is a trade-off; you’ll have debt with a bank, and you might have to give up part of your company to investors (depending on the terms).

Conclusion

So when your business owner says, “let’s increase sales!”, remember focus on making profitable sales. Look at improving the Cash Conversion Cycle to make the most of your internal resources.  Consider outside financing when/if your existing return on assets won’t get you where you want to be.

Don’t crash and burn – make sure your company has the fuel it needs. Your business owner is looking to you to help them grow their business. To learn how to do it, access the free How to be a Wingman whitepaper here.

improving profitability instead of sales

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

improving profitability instead of sales

1

Unlock Cash in Your Business

unlock cash in your business

Unlocking cash in your business can make a major impact on valuation, cash flow, profitability, and so much more.  As the saying goes, “Cash is King.” However, there is often money lying around that is essentially “locked up” in the system.

Unlocking Liquidity

Liquidity is key to success. A company could sell all the widgets in the world and have a great net earnings, but still go out of business if it can’t collect paymentsFailure to meet this simple obligation has landed many companies in a cash crunch with Mr. Chapter 11 lurking.

Liquidity =  ability to convert assets to cash

Why is liquidity important? Liquidity is vital to a company. It’s like the blood that runs through your veins. If your blood forms clots within arteries and veins, then you could suffer a heart attack.  Just like the blood coursing through our bodies, freely flowing cash is vital to a healthy company.

unlock cash in your businessReducing DSO

A little improvement goes a long way when unlocking cash in your business.  First things first… Take a look at your DSO, or daily sales outstanding. What is it running?

Oftentimes with our clients, we start by reducing DSO 1-2 days. Depending on the size of the company, this one change could easily create a great deal of free cashFor example, we consulted with a $10 million company that collected every 365 days. If we freed up just 5 days through DSO optimization strategies, it would result in almost $137,000 of free cash!

Small improvements can free up substantial cash within your business.

Here’s an example of how a little goes a long way.  A few years ago, we changed our processes to invoice within 24 hours. This reduced our DSO by 10 days.  Simple things like setting up rules and procedures for invoicing put you in a position to better manage liquidity.

(For more tips on how to optimize your accounts receivable, download your free checklist here.)

What to do in a Cash Crunch

Cash crunches can either be foreseeable or can completely blindside you. Economic downturns, vendors filing for Chapter 11, or a natural disaster, such as a wildfire, can have detrimental impacts on your cash position unless you have the knowledge and skills to cope with cash crunches.

Over several years, I’ve noticed that many companies who find themselves in a cash crunch are investing heavily in technology. While that may not be a bad thing, companies may become over-reliant on the new system and forget that it’s still important to monitor and manage internal processes – namely DSO.

If this is you, there are some options that you can act on to improve DSO:

Slow-moving accounts receivable can hurt a company by tying up cash.  These assets aren’t easy to liquidate in a cash crunch, especially if the crunch is caused by factors that are affecting your customers as well.  It’s important to manage your receivables process to make sure customers are current so the cash keeps coming in.

Example: Sitting on a Desk

CPA firms, law firms, and other professional services are notorious for insisting that all partners review each invoice before they are sent out to the client. The invoices (aka, cash) are essentially sitting on a desk, waiting to be approved. Sometimes, they get lost in the paperwork and are finally sent out 60 days after the service has been completed. Assuming the customer pays within 30 days, the receivable is 90 days old before the cash is in the door.

Let’s look at 2 issues:

#1 Partners are busy.

They simply don’t have time. They should be focused on doing the work, not reviewing invoices. Develop a procedure or invest in systems that circumvent this step.

#2 Each partner has to review the bill.

By having a number of busy partners reviewing invoices, there’s a high chance that it will a) get lost, b) get changed in error or misunderstood, c) get sent out late.

There’s something that most of these firms do not understand: the tradeoff between having a perfect invoice and getting cash quickly.

One firm that I consulted with was in the habit of mailing their invoices 30-60 days after the service was completed. There was no goal on when to mail invoices.  We helped them transition into a position where they mailed invoices within 24 hours of delivering the service. Their DSO was 42, which wasn’t terribly bad.

Then we convinced them to email clients their invoices the day of, reducing their DSO to 38. This was no simple feat. We had to figure out who needed the invoices for processing and we had to train their customers that emailing invoices the day of was the new norm. These are two important factors that you have to acknowledge as you undertake this technological change.  Don’t overlook something as simple as who is receiving the invoiceBusiness owners will likely let your invoice sit in their inbox whereas A/P clerks will make sure it gets put into the accounting system.  While these changes took a little time to adjust to, they saw significant improvement in their cash flow.

Don’t be afraid to ditch old practices.

Value Creation

Are you looking to sell your company in the near future? By reducing your DSO and optimizing your accounts receivable, you’ll be in a better position to add value to your company.

The purpose of business valuation is to assess the capacity a company has to grow. Use this when a company is trying to sell or merge with another firm.

Where To Create Value

It all begins with your revenue growth and profitability. These two metrics can be impacted by cash tied up in accounts receivable. By reducing DSO a certain number of days (depending on what your DSO is currently), you’ll be able to prove to any buyer that your company is able to generate free cash flow.

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.

AR Checklist

Strategic CFO Lab Member Extra

Access your Projections Execution Plan in SCFO Lab. The step-by-step plan to get ahead of your cash flow.

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

Click here to learn more about SCFO Labs

SCFO-Lab-Graphic

2

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 Effective 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.

3

Strategic CFO Lab Member Extra

Access your Flash Report Execution Plan in SCFO Lab. The step-by-step plan to manage your company before your financial statements are prepared.

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

Click here to learn more about SCFO Labs

Collection Effectiveness Index

8

CEI vs DSO

Cash is king. CEIA 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

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

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

See also:

Examples of DSO

4