AR – Collection Effectiveness

AR Collection Effectiveness is a KPI that measures the ability of a company to collect payments from customer in timely manner. The term “collection” is vague and many organizations differentiate between receivables and collections. For sake of simplicity, the assumption here is that “Collection” denotes ALL receivables including due and overdue amounts.

Finance PerspectiveCEI Collection Effectiveness Index (CEI) from the perspective of Finance looks at account balances at different time periods to arrive at the value. The picture shows how the values are derived, which is industry wide accepted definition for CEI.

AR Collection Effectiveness described here varies slightly from the Financial perspective option and instead looks at details of invoice time periods for analysis. The quantum of invoice value that was expected to be collected during a time frame versus the quantum actually collected during the same reference time frame gives a percentage value that can be seen as effectiveness of collection activity.

Example Reference time frame is Apr-2016.

Number of All (i.e. Open and Paid) Invoices with Due Date falling on or before 30-April-2016 12
Value of All Invoices with Due Date falling on or before 30-April-2016 2500
Value of Payments received against Invoices identified earlier 2200
Collection Effectiveness 88%

The above method is a high level mechanism to measure effectiveness of collection activities. Many scenarios in real-time have to be factored into account and fine tuned as per individual organization(s) requirement. Some special scenarios are

  • How should overdue be handled
  • Partial payments received
  • Agreements / Contracts handing e.g. AMC

Collection effectiveness illustrated here will not match Collection Effectiveness Index (CEI) that is derived from financial statements. Both methods essentially show the same performance measure for Accounts Receivable as a whole but vary in their approach. Method discussed here takes a detailed approach and looks at individual transactions to calculate the final KPI value.