The Collection Effectiveness Index (CEI) is a financial metric that measures the companies efficiency in collecting outstanding receivables within a specific period. CEI is calculated as a percentage of total potential receivables that were collected.
A higher the Collection Effectiveness indicates that the collection process is more efficient, while a lower CEI may indicate that the collection process has some issues, such as invoicing or policy problems.
Collection Effectiveness Index (CEI) calculation:
- Sum the beginning accounts receivable and the monthly credit sales.
- Subtract the ending total receivables from the sum.
- Divide the total by the difference between your beginning accounts receivable balance and monthly credit sales and the ending current receivables.
- Multiple the result by one-hundred to get the percentage.
When the Collections Effectiveness Index is low the following are potential areas for improvements:
- Invoicing Errors: Too many customer disputes due to invoicing errors or invoices being sent late.
- Collection Process: The process is not consistent or organized. May lack automation or the correct technology to help with organization.
- Credit Policy: A lenient credit policy, allowing more risk into the portfolio, and thus, more bad debt.
- Ease of Payment: You may not be making it easy enough for customers to pay. Open up payment options to enable more options for customers.
Options to improve your Collections Effectiveness index:
- Dispute Management: Implement a clear process with service level agreements on timelines to resolve customer disputes to avoid long delays in payments.
- Invoicing: Ensure you have a solid process for e-invoicing and customer sign-up for the process, so that invoices are sent and recieved immediately.
- Credit Policy: Enact a clear credit policy with a consistent approach to credit applications and collection. Have the ability to review the perceived risk within your customer portfolio and amend policy as necessary.
- Payment Terms and Options: Have guidelines on payment terms offered to customers and ensure you have multiple options for customers to make payments.
- Technology: Review your technology stack to ensure you have a level of automation that ensures your collection process is not completely manual and has flexibility to change based on your companies needs or economic indicators.
- Segmentation: Review your customer base and have a tailored approach for different customer segments. One size, does not fit all.
Ultimately, you will need to understand the needs of your company and be able to adapt your credit and collection approach accordingly. As an example, if in a growth mode, and have the need to penetrate a market, you may be taking on additional risk and adapt your collections approach accordingly. This may mean that your Collections Effectiveness Index (CEI) will trend downwards, but does not necessarily mean you have an overall issue. It is the understanding of the cause and effect that is key.
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