Collection Effectiveness Index Definition
Collection Effectiveness Index (CEI) is an accounts receivable metric that measures accounts receivable management efficiency. Credit and collection professionals use it to determine payment recovery effectiveness.
CEI provides collection effort insights for a small business and larger organizations.
Many companies use accounts receivable software or other accounting software to gain real-time visibility into collection effectiveness index and collection metrics.
How to Calculate Collection Effectiveness Index
The formula for calculating the collections effectiveness index is:
CEI = ( Beginning Receivables − Ending Receivables)/( Beginning Receivables) − Credit Sales) × 100
Here's what each component of the AR KPI represents:
- Current Receivables: The total receivables at the beginning of a period.
- Ending Receivables: The total receivable balance at the end of the same period.
- Credit Sale: The monthly credit sales made.
The resulting percentage shows the collection effectiveness during the collection period.
A high CEI suggests efficient cash collections, and a low CEI shows challenges in the accounts receivable performance.
Collection Effectiveness Index Example
Let's walk through an example to illustrate how to calculate CEI.
Suppose a company has the following financial information for a specific period:
- Beginning Receivables: $100,000
- Ending Receivables: $80,000
- Credit Sales: $50,000
Now, we can use the formula to calculate the CEI:
CEI = ( Total Receivables − Ending Receivables ) / Current Receivables − Credit Sales) × 100
Collection Effectiveness Index = (100,000−80,000)/(100,000−50,000) × 100
CEI = (20,000)/(50,000) × 100
CEI = 0.4 × 100
CEI = 40%
In this example, the Collection Effectiveness Index is 40%, showing that the company could collect 40% of current receivables.
This value depends on industry benchmarks and the company's historical performance. A higher CEI is favorable.
What is a good collection effectiveness index ratio?
A higher CEI ratio is considered better. A ratio above 80% indicates effective accounts receivable management. Late payments, net credit sales, and unclear net terms negatively affect it.
What is the relationship between CEI and the Accounts Receivable Turnover Ratio?
- Both CEI and accounts receivable turnover ratio provide insights into AR collection efficiency, but they approach it from different perspectives.
- CEI focuses on accounts receivables collection during a period, emphasizing the collection efforts success.
- ARTR examines account receivable turnover throughout the year, providing a perspective on how a company converts credit sales into cash.
While CEI gives a snapshot of collections process efficiency for a specific period, ARTR provides a more comprehensive AR management view. Both contribute to a holistic understanding of a company's accounts receivable process, performance, and cash flow impact.
Note: CEI evaluates debt collection efforts over a period without involving personal information to ensure privacy and compliance.
Collection Effectiveness Index Importance
- Efficiency Measurement: CEI quantitatively measures how efficiently a company manages its accounts receivable and collects outstanding debts. It helps assess credit and collection process effectiveness, allowing average collection period calculation.
- Cash Flow Management: A high CEI shows that a company collects its invoice on time and converts credit sales to cash. Efficient collections improve liquidity and financial stability and facilitate better cash flow management.
- Performance Benchmarking: CEI lets companies compare their collection efficiency in different timeframes and industry benchmarks. Effective CEI also ensures quick and accurate cash application.
- Credit Risk Assessment: Monitoring CEI helps assess customer credit risk. A declining CEI signals potential issues with invoice payment, allowing the company to take proactive measures for credit risk management.
- Decision-Making: By tracking CEI regularly, management can make informed decisions regarding credit policies, collection strategies, and resource allocation for credit and collection activities.
- Investor and Creditor Confidence: Consistently high CEI enhances investor and creditor confidence in a company's financial management.
Note: The collection effectiveness index measures debt collection efficiency, while average accounts quantify managed or affected accounts.
Difference Between CEI and Days Sales Outstanding
Collection effectiveness index and Days Sales Outstanding (DSO) are vital financial management metrics in accounts receivable. They serve different purposes and provide insights to track accounts receivable KPIs.
CEI focuses on cash collection management. It calculates the outstanding receivables a company collects during that period. The formula compares receivables to credit sales. A low CEI means the sales ratio is high, but payments aren't collected on time, giving rise to bad debt.
DSO is another receivable KPI that focuses on average days to collect an outstanding invoice after a sale. It measures payment terms and provides insight into collections process and credit management. A low DSO shows a quicker collection and cash conversion cycle.
CEI monitoring and improvement are critical for cash flow optimization, liquidity improvement, and financial position maintenance.
FAQs
What is collection efficiency index?
The Collection Efficiency Index measures how well a company collects cash within a given period, comparing collected amounts to the amount of receivables available for collection at the start and end of the period.
How do you interpret collection effectiveness index?
Assess its percentage: values closer to 100% indicate effective debt collection, while lower ones suggest room for improvement in total receivables.
How do you measure effectiveness of collections?
Measure the collection effectiveness with CEI calculation, which compares total receivables collected to the amount available for collection, highlighting the efficiency of the collection process over a specific period.
What is a good CEI ratio?
A good Collections Effectiveness Index ratio is above 80%.
