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    2 Tools That Will Improve Your A/R Collection Effectiveness

    Master DSO (Days Sales Outstanding) and ADD (Average Days Delinquent) — two essential metrics for understanding and improving your organization's accounts receivable collection.

    Thought LeadershipJanuary 18, 2016CRiskCo

    There are many opinions concerning methods for measuring the efficiency of collecting A/R. In this article, we will discuss the most common method for calculating and measuring the effectiveness of your organization's A/R collections.


    Why Measure Collection Effectiveness?


    Most organizations do not measure it in a controlled and constant way. They usually do not even compare it to previous results. In fact, most organizations do not really know if their collections have become better or worse.


    Measuring collection efficiency has some distinct advantages:


  1. When measuring the collection, you also get a strong clue about your sales
  2. When knowing how long it takes for your organization to collect, you can improve how you give credit to your customers
  3. You improve the collection department efficiency and functionality
  4. The biggest advantage is that you can tell which customers are receiving credit but aren't worthy of it

    5. DSO — Days Sales Outstanding


    The most common way to measure the effectiveness of the organization's collection.


    What is DSO? DSO is a calculation that measures the average days it takes for an organization to collect its revenues.


    How to calculate DSO:


    DSO = (Total A/R ÷ Total Credit Sales) × Duration in Days

    Example: In 2015 you made sales at $10 million. At the end of the year, there are still unpaid invoices totaling $1.2 million.


    DSO = ($1,200,000 ÷ $10,000,000) × 365 = 43.8 days

    What is a "good" DSO? The rule of thumb for normal DSO is lower than 45 (when payment terms are net+30), but you should compare your DSO score to similar organizations (in terms of industry, size, and location), as well as compare your current DSO to previous results.


    ADD — Average Days Delinquent


    The DSO alone is not enough. To get a clearer picture, you need ADD — the average number of days the payment is made after the invoice due date.


    First, calculate Best DSO:


    Best DSO = (Current A/R ÷ Total Credit Sales) × Duration in Days

    Example: Current (non-delinquent) A/R = $800,000


    Best DSO = ($800,000 ÷ $10,000,000) × 365 = 29.2 days

    Then calculate ADD:


    ADD = DSO − Best DSO = 43.8 − 29.2 = 14.6 days

    Analyzing DSO and ADD Together


  5. Both decline together — Your collection department is doing a better job, collecting payments faster.
  6. Both rise together — Collections are delayed. Customers pay late more often and cash flow is less stable.
  7. They move in opposite directions — The answer is complex. A falling DSO may look like improvement, but if ADD is rising, customers are actually paying later. The DSO improvement may be explained by changes in payment terms or other factors unrelated to collection efficiency.

    8. Tracking your ADD alongside the DSO will provide a rich, full picture about your organization's collecting efficiency and about the ability to turn Accounts Receivable into cash.

    DSOADDaccounts receivablecollection performancefinance KPI