I recently gave an online presentation about how schools can improve their billing function, which you can view here: Four Ways to Improve Your Billing Processes. But as I was putting the presentation together I realized there was information regarding the collection of receivables that could help any organization. If you have a receivables balance of any type, using the following metrics can set the stage for improving your ability to collect receivables.
Days Sales Outstanding (DSO) is a popular way to evaluate how effective you are at collecting receivables. Of course, “sales” means a number of different things to nonprofits such as pledges, tuition, grants, or service fees. DSO is calculated by taking the average receivable balance for a period, for example the fiscal year, and dividing by total billed revenue for that same time period, then multiplying by the number of days in the period.
Days Sales Outstanding = (Average Accounts Receivable / Billed Revenue) x Days
Your accounting software should be able to provide this information. The quick way to get the average accounts receivable balance is to add the receivables balance at the beginning of the period to the balance at the end of the period and divide by two.
Knowing where you are is critical to understanding where you want to go. Since cash drives so much of your organization’s activities, you should aim to collect accounts receivable as quickly as possible. The best practice is 45 days, and while it’s a good target, you’ll want to know where your organization is and create goals from there.
You can start to set some goals by utilizing what’s known as Best Possible Days Sales Outstanding. This formula is the same as before, except we replace the average receivables with the just the current receivables balance. The closer your regular DSO is to your Best Possible DSO, the closer your receivables are to the optimum level.
Best Possible Days Sales Outstanding = (Current Accounts Receivable / Billed Revenue) x Days
Be careful with using DSO by itself as a measure of how well you are collecting receivables, as it has a key weakness. Since it fluctuates with revenue, a sudden dip in revenue will cause it to rise significantly even if your average receivables balance is steady. So analyzing DSO on a period less than a year can be misleading.
Average Days Delinquent calculates the average time from a receivable’s due date to its paid date. In other words, it’s the average number of days that invoices are past due. It provides a snapshot to evaluate your overall collection performance. ADD is calculated by taking standard DSO less the best possible DSO.
Average Days Delinquent = Days Sales Outstanding – Best Possible Days Sales Outstanding
Armed with these metrics, you can begin to evaluate where your organization stands and begin to set some goals for where you can improve in the future.
What are some of the metrics your organization has used to measure the effectiveness of your collections processes?