7 AR Aging Metrics for Better Cash Flow

Struggling with cash flow? Late payments now account for 49% of B2B sales, with businesses waiting an average of 73 days to get paid. Tracking the right AR (Accounts Receivable) metrics can help you avoid cash flow problems and improve collection efficiency. Here are the 7 key metrics you need to monitor:

• Days Sales Outstanding (DSO): Measures how quickly you collect payments. Aim for under 45 days.
• Average Days Delinquent (ADD): Tracks how late payments are, highlighting overdue invoices.
• AR Turnover Ratio: Shows how often you collect receivables in a given period. Higher is better.
• Collection Effectiveness Index (CEI): Evaluates how efficiently your collection process converts receivables to cash.
• Percentage of AR Over 90 Days: Identifies invoices overdue by 90+ days. Keep this as low as possible to avoid bad debt.
• Best Possible DSO (BPDSO): Represents the ideal time to collect receivables under perfect conditions.
• Cost Per Collection Dollar (CPCD): Reveals how much it costs to collect each dollar of revenue. Lower costs mean better efficiency.

Quick Comparison

1. Days Sales Outstanding (DSO)

Days Sales Outstanding (DSO) measures how many days, on average, it takes your business to collect payment after making a credit sale. It’s a critical metric - the shorter the timeframe, the quicker your invoices turn into cash in your account.

"Days sales outstanding (DSO) reveals how quickly you convert credit sales into cash, directly impacting your working capital." - JPMorgan Chase

DSO serves as a key indicator of how efficiently your accounts receivable (AR) are managed. A high DSO suggests delays in payment collections, which can lead to cash flow challenges. A low DSO, on the other hand, reflects faster cash conversion.

How to Calculate DSO

The formula for DSO is:
DSO = (Accounts Receivable ÷ Net Credit Sales) × Period

Alternatively, you can use the average accounts receivable:
DSO = (Average AR ÷ Net Revenue) × 365

To calculate the average accounts receivable:
Average AR = (Beginning AR + Ending AR) ÷ 2

For example, if a company reports $30,000 in credit sales and has $20,000 in receivables over a 40-day period, the DSO is:
($20,000 ÷ $30,000) × 40 = 26.6 days
This indicates efficient collections.

Industry Benchmarks and Their Importance

Comparing your DSO to industry standards helps assess how well your collections process is performing. A DSO under 45 days is typically considered strong. The overall median DSO across industries is 56 days, while the median for companies in Q3 2022 was 37.30 days.

These benchmarks highlight operational gaps. For instance, businesses using manual AR processes often experience 30% longer DSOs compared to those with some level of AR automation. Such insights can guide efforts to improve collections and streamline operations.

Strategies to Reduce DSO

Lowering your DSO can improve cash flow and free up funds for reinvestment. Here are some effective strategies:

• Speed up invoicing: Send invoices promptly and ensure they are accurate. Include clear payment terms and due dates, and verify customer billing information. Automated invoicing tools can help reduce errors and maintain consistency.
• Offer flexible payment options: Accept credit cards, online payments, and automatic transfers to make it easier for customers to pay quickly.
• Provide early payment incentives: Terms like "2/10 net 30" (2% discount for payments within 10 days) can encourage faster payments while improving cash flow.
• Enhance your credit approval process: Conduct thorough credit checks for new customers and regularly review credit limits for existing ones to minimize the risk of late payments.
• Automate follow-ups: Use automated email reminders for upcoming and overdue payments. Address disputes promptly to avoid delays, and segment customers by payment behavior for tailored communication.

"For companies looking at top-line revenue growth, DSO, not just the number of contracts signed, is an important indicator of revenue that will actually hit the books. DSO can help answer the question of whether the product is delivering and customers are being served." - Riya Grover, CEO of Sequence

Track your DSO consistently and compare it against industry benchmarks. By doing so, you can identify areas for improvement and refine your overall AR aging strategy, ensuring smoother cash flow and better financial health.

2. Average Days Delinquent (ADD)

Average Days Delinquent (ADD) zeroes in on overdue payments, measuring how many days past their due date invoices remain unpaid. Unlike DSO, which provides a broader view of overall payment collection, ADD hones in specifically on late payments, offering a clearer picture of delays.

If your ADD is high, it might point to problems in your collections process - like slow follow-ups or unclear payment terms - that wouldn’t necessarily show up in your DSO.

How to Calculate ADD

To calculate ADD, you’ll need to follow three steps, using both your DSO and Best Possible Days Sales Outstanding (BPDSO):

Let’s break it down with an example: Walker's Widgets has $80,000 in total receivables and $120,000 in net credit sales over 90 days, giving a DSO of 60 days. With $32,000 in current receivables, their Best Possible DSO is 24 days. Subtracting that from the DSO, the ADD comes out to 36 days. This means invoices are paid, on average, 36 days past their due date.

By isolating late payments, ADD provides a more targeted view of collection delays, complementing the broader DSO metric.

Why ADD Matters for Collection Effectiveness

ADD shines a spotlight on late payments, helping you identify inefficiencies in how overdue invoices are handled. Tracking this metric allows you to fine-tune your follow-up process, adjust credit terms, and create more effective reminder schedules. For example, you can segment customers based on their payment habits and send tailored reminders to those with overdue invoices.

While DSO gives you a general sense of how long it takes to collect payments, ADD focuses solely on overdue invoices - offering a sharper lens to uncover and address recurring payment delays.

3. Accounts Receivable Turnover Ratio

The Accounts Receivable Turnover Ratio shows how effectively your business turns credit sales into cash. It measures how many times, on average, your receivables are collected within a specific period. A higher ratio reflects efficient collections and steady cash flow.

In simpler terms, this ratio tells you how often your company collects its outstanding receivables over a set timeframe. A higher number means you're doing a good job of collecting payments, which keeps your cash flow healthy and predictable.

How to Calculate the AR Turnover Ratio

To calculate this ratio, you’ll need two main figures: net credit sales and average accounts receivable.

Accounts Receivable Turnover Ratio = Net Credit Sales ÷ Average Accounts Receivable

Here’s how to break it down:

• Net Credit Sales: Total credit sales minus any returns or allowances.
• Average Accounts Receivable: Add the beginning and ending receivables for the period, then divide by two.

For example, imagine TechFlow Solutions recorded $480,000 in net credit sales last year. Their accounts receivable balance was $60,000 at the start of the year and $80,000 at the end, averaging $70,000. Using the formula, their AR turnover ratio would be 6.86 ($480,000 ÷ $70,000). This means they collected their receivables almost seven times in one year.

Why Higher Ratios Are Good for Cash Flow

A higher turnover ratio means cash is coming into your business more frequently. Efficient collections allow you to cover expenses, fund growth, and manage financial obligations without relying heavily on loans or other external funding.

"The accounts receivable turnover ratio is one metric to watch closely as it measures how effectively a company is handling collections. If money is not coming in from customers as agreed and expected, cash flow can dry to a trickle." - Scott Beaver, Sr. Product Marketing Manager, NetSuite

That said, context is important. If your ratio is too high, it might indicate overly strict credit policies, which could discourage potential customers and hurt sales. The goal is to strike a balance between timely collections and maintaining good customer relationships.

Using AR Turnover for Better Planning

This ratio can help you forecast cash flow more accurately. Knowing how quickly customers typically pay can guide decisions about covering expenses, making investments, or preparing for seasonal changes. A strong and consistent turnover ratio also makes your business more appealing to lenders, improving your chances of securing financing when needed.

To get the most out of this metric, compare your ratio to industry benchmarks. As of Q1 2024, turnover ratios vary widely across industries. Understanding where you stand in comparison to your peers can highlight areas for improvement and refine your overall accounts receivable strategy.

4. Collection Effectiveness Index (CEI)

The Collection Effectiveness Index (CEI) is a percentage-based metric that shows how efficiently your company collects receivables over a set period. It offers a clear picture of how well your collections process is working by highlighting the portion of receivables successfully turned into cash. Unlike some metrics, CEI adjusts for sales volume, making it a reliable measure of your collection team's performance.

Interestingly, a recent survey found that 42% of business and finance leaders rank CEI among their top three accounts receivable (AR) key performance indicators (KPIs). Its appeal lies in its ability to evaluate collection efforts without being skewed by sales growth.

How to Calculate CEI

Here’s the formula to calculate CEI:

CEI = [(Beginning AR + Credit Sales - Ending Total AR) ÷ (Beginning AR + Credit Sales - Ending Current AR)] × 100

Where:

• Beginning AR: The receivables balance at the start of the period.
• Credit Sales: Total credit sales made during the period.
• Ending Total AR: The total outstanding receivables at the end of the period, including overdue amounts.
• Ending Current AR: Receivables from sales made during the same period, excluding overdue amounts.

Let’s break it down with an example. Suppose a company starts the month with $6,000 in receivables, records $4,130 in credit sales, and ends the month with $6,200 in total receivables, of which $4,000 are current. The CEI calculation would look like this:

CEI = [($6,000 + $4,130 - $6,200) ÷ ($6,000 + $4,130 - $4,000)] × 100 = 64%

Understanding and Using CEI Results

A higher CEI reflects strong credit management and an effective collections process. Typically, a CEI of 85% or higher is seen as excellent, while anything below 80% may indicate issues that need immediate attention. Since CEI focuses solely on collections, it can reveal problems even when sales are growing.

If your CEI takes a dip, it might signal issues like delayed invoicing, overly flexible credit policies, limited payment options, or insufficient prioritization of customer accounts. Regularly monitoring CEI allows you to spot trends that could impact cash flow, minimize bad debt risks, and maintain financial stability.

For companies experiencing growth, keeping an eye on CEI ensures that collections keep pace with increasing sales. At Phoenix Strategy Group, we recommend that businesses routinely analyze metrics like CEI to strengthen cash flow management and maintain financial health. Regular CEI reviews are a critical part of a solid AR strategy.

Up next, we’ll explore how the age of receivables affects collection rates and cash flow planning.

5. Percentage of AR Over 90 Days

The Percentage of AR Over 90 Days is a critical metric that flags potential issues with bad debt and cash flow. It measures the share of your accounts receivable (AR) that have remained unpaid for more than 90 days since the date of service. A rising percentage here is a red flag, signaling potential trouble in collecting payments and threatening your financial stability.

This metric essentially acts as a warning light for collection challenges that could escalate into write-offs. The longer receivables remain unpaid, the harder they are to collect. By the time accounts hit the 90-day mark, they often require significant effort to recover and may ultimately turn into bad debt.

How to Calculate Percentage of AR Over 90 Days

The formula to calculate this is simple:

Percentage of AR Over 90 Days = (AR in 90+ Days Aging Bucket ÷ Total AR Outstanding) × 100

For example, if your total outstanding receivables amount to $50,000 and $8,000 of that is over 90 days old, the calculation would look like this:

($8,000 ÷ $50,000) × 100 = 16%

It’s essential to base this calculation on the date of service, not the last billed date, to ensure accuracy.

Industry Thresholds and Benchmarks

While acceptable levels differ by industry, some general benchmarks can guide you:

• Physician practices: Less than 15%
• Hospitals: Less than 20%
• Home care agencies: 15–20% (top performers manage to keep it at 10% or below)
• General business: 10–15% is the typical range

The Medical Group Management Association (MGMA) advises that total AR over 90 days should stay below 25%. Top-performing organizations often aim for 10% or less.

Digging Deeper into the Analysis

To get the most value from this metric, break it down into more specific categories. For example, calculate separate percentages for insurance receivables versus patient receivables, as they often require different approaches. You can also segment by financial class or key payers to pinpoint problem areas.

Here’s an example: Your overall percentage might seem fine, but a closer look could reveal that self-pay accounts over 90 days exceed 30%. This would highlight the need to improve your patient collection processes.

Why It Matters for Financial Health

When the percentage of AR over 90 days exceeds recommended thresholds, it can set off a chain reaction of financial challenges. High levels of aged receivables can tighten cash flow, making it harder to meet obligations like payroll or vendor payments. This can lead to increased write-offs, bad debt expenses, and even delays in growth or expansion plans.

Tracking this metric regularly can help you identify and address issues before they spiral out of control. Common culprits behind high percentages include billing delays, poor denial management, and unclear collection policies.

At Phoenix Strategy Group, we’ve seen firsthand how businesses that keep their 90+ day receivables under control enjoy healthier cash flow and more predictable financial outcomes. Keeping a close watch on this metric is a cornerstone of effective AR management.

This naturally leads into exploring how to design an optimal collection timeline that aligns with your specific business model.

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6. Best Possible Days Sales Outstanding (BPDSO)

Building on the concept of DSO, BPDSO represents the best-case scenario for how efficiently your business can collect receivables. It reflects the shortest possible time it would take to collect current receivables if all non-overdue payments were made immediately. Essentially, BPDSO gives you an ideal benchmark for collection performance.

How to Calculate BPDSO

Here’s the formula for BPDSO:

BPDSO = ((Current Receivables – Past Due Receivables) ÷ Total Credit Sales) × Number of Days

Let’s break it down with an example. Imagine Company ABC made $30,000 in credit sales during February (28 days). By the end of the month, its total receivables were $10,000, with $2,000 of that past due.

BPDSO: ($8,000 ÷ $30,000) × 28 ≈ 7.47 days

This means, under perfect conditions, Company ABC could collect its receivables in about 7.5 days. Once you calculate your BPDSO, you can compare it to your actual DSO to pinpoint inefficiencies in your collection process.

Why Comparing BPDSO to Actual DSO Matters

The real insight comes from comparing your actual DSO to your BPDSO. This comparison reveals how much room there is to improve your collection efficiency. A large gap between these numbers often signals delays in payments, which could be straining your cash flow.

"Tracking the delta between Best DSO and Standard DSO will ensure that you are optimizing your business' account receivable (AR) management practices and help identify opportunities to improve cash flow." - Nicole Dwyer, SVP of ICA Portfolio Strategy

Ideally, your actual DSO should be within 20% of your BPDSO. For instance, if your BPDSO is 10 days and your actual DSO is 18 days, you’re operating at about 80% efficiency. However, if your actual DSO is 25 days, efficiency drops significantly, signaling a need for major improvements in your collections process.

Factors That Widen the Gap

Several common issues can create a gap between BPDSO and actual DSO:

• Lenient credit approval practices may allow high-risk customers, increasing the likelihood of payment delays.
• Errors or delays in invoicing can push back payment timelines before customers even receive their bills.
• Poor follow-up on disputes or inconsistent collection efforts can further drag out collection cycles.

The good news? These issues are manageable. Tightening credit policies, ensuring invoices are accurate and sent promptly, and adopting proactive collection practices - like automating reminders and tracking payments - can go a long way in closing the gap.

7. Cost Per Collection Dollar

Cost Per Collection Dollar (CPCD) tells you how much it costs your business to collect each dollar of revenue. By dividing total collection costs by the amount collected, this metric highlights how efficiently your resources are being used. It can help uncover inefficiencies and guide better allocation of resources.

How to Calculate Cost Per Collection Dollar

Cost Per Collection Dollar = Total Cost of Collecting Payments ÷ Total Dollars Collected

When calculating CPCD, include all costs tied to revenue collection. This includes salaries, technology expenses, overhead, and collection fees. On the other side, total dollars collected should account for all payments received from customers, insurance companies, and other payers.

Here’s an example: If a hospital spends $5 million on revenue cycle operations and collects $150 million in payments, its CPCD would be 3.33%. In other words, the hospital spends 3.33 cents to collect every dollar in revenue.

What Your CPCD Numbers Mean

For high-performing organizations, CPCD usually falls between 2% and 4%, with best practices leaning closer to 2–3%. A recent report from healthcare financial leaders found the average CPCD to be 3.68%. If your CPCD is over 5%, it’s a red flag indicating inefficiencies in your collection process.

A high CPCD eats into profit margins, while a low CPCD reflects a more efficient operation. Lowering CPCD isn’t just about cutting costs - it’s about streamlining processes to ensure revenue is collected faster and with fewer resources. This metric provides a roadmap for improving financial performance.

"Understanding this metric can reveal hidden inefficiencies and highlight opportunities for improvement that will ultimately help hospitals keep more of what they earn. Optimizing cost-to-collect is a major step toward long-term financial stability." – OA Editorial Team, Publisher, Office Ally

If you’re looking to bring down CPCD and improve cash flow, the following strategies can make a big difference.

Strategies to Lower Your Cost Per Collection Dollar

• Automate routine tasks. Automation can save time, reduce manual errors, and speed up collections. Tools like automated invoice reminders, recurring invoices, and electronic payment options (e.g., ACH transfers) cut down on labor costs while improving efficiency.
• Tighten credit policies. Evaluate client creditworthiness before extending terms. For higher-risk customers, consider requiring credit card payments. For example, in March 2020, Lindemann Chimney Supply shifted 95% of its customers to credit card payments, reducing its average days sales outstanding from over 40 days to 27 days (Source: NetSuite, 2022).
• Enhance client communication. Clear communication about billing and offering flexible payment options can encourage faster payments. Train staff to handle accounts receivable discussions effectively, and address any billing issues promptly.
• Focus your resources strategically. Allocate your most expensive collection efforts to larger balances rather than smaller, individual invoices. This ensures you’re getting the best return on your investment.

AR Metrics Comparison Table

The AR Metrics Comparison Table simplifies performance tracking and helps pinpoint areas that need attention. It provides a quick reference for benchmarking key metrics and taking corrective actions.

Consistent reviews of these metrics can help improve cash flow. Aim to review open invoices weekly or bi-weekly and compare your performance to industry standards. If multiple metrics show underperformance, prioritize the ones that will have the biggest impact. For instance, if your percentage of AR over 90 days is high, address those accounts first since 52% of invoices overdue by 90 days are often written off.

For expert assistance in refining your AR processes and enhancing cash flow, reach out to Phoenix Strategy Group.

Conclusion

Keeping a close eye on your accounts receivable (AR) is crucial for maintaining healthy cash flow. With cash flow challenges looming over many businesses, tracking AR aging metrics has never been more important.

Metrics like Days Sales Outstanding (DSO) and Cost Per Collection Dollar provide actionable insights to fine-tune your credit policies and collection efforts. This kind of precision is especially critical in today’s tough financial climate.

Consider this: a 2023 Atradius survey revealed that late payments now account for 49% of all B2B sales, with businesses waiting an average of 73 days to get paid. On top of that, bad debts represent 6% of all B2B invoices. These numbers highlight just how essential it is to have strong AR tracking systems and clear collection strategies in place.

To get started, focus on metrics that directly address your biggest challenges. If cash flow is tight, prioritize DSO and AR Turnover Ratio. Struggling with consistent late payments? Shift your attention to Average Days Delinquent and Percentage of AR Over 90 Days. Early action is key to avoiding costly write-offs.

For businesses looking to take their AR management to the next level, Phoenix Strategy Group offers tailored financial advisory solutions. Their fractional CFO services and data engineering expertise can help transform AR metrics into actionable strategies that fuel growth. As DataPath Co-CEO David Darmstandler put it:

"As our fractional CFO, they accomplished more in six months than our last two full-time CFOs combined. If you're looking for unparalleled financial strategy and integration, hiring PSG is one of the best decisions you can make."

The bottom line? Regular monitoring and timely action are non-negotiable. Review your AR aging reports weekly, set performance benchmarks, and adjust your collection strategies as needed. Your cash flow - and your business - depend on it.

FAQs

What are the best ways to reduce Days Sales Outstanding (DSO) and improve cash flow?

Reducing Days Sales Outstanding (DSO) plays a critical role in boosting cash flow and keeping your finances in check. Here are some practical strategies to achieve this:

• Speed up invoicing: Leverage automated tools to send invoices promptly and accurately, ensuring they reach customers without delay.
• Set clear payment terms: Clearly state payment deadlines and terms on every invoice so there's no confusion about when payments are due.
• Provide convenient payment options: Offering a variety of payment methods, such as credit cards or online payment portals, can encourage quicker transactions.
• Stay on top of follow-ups: Use a consistent system to send reminders for overdue invoices, helping to keep payments on schedule.
• Review credit policies regularly: Assess customer creditworthiness periodically and adjust terms as needed to reduce the risk of late payments.

By implementing these steps, you'll not only speed up collections but also create a smoother, more effective accounts receivable process.

How can I reduce the Cost Per Collection Dollar (CPCD) in my business?

To lower your Cost Per Collection Dollar (CPCD) and improve cash flow, refining your accounts receivable process is key. Start by automating repetitive tasks like sending payment reminders and follow-ups. This not only saves time but also cuts down on labor expenses. At the same time, make sure invoices are accurate and sent out quickly - errors or delays can slow down payments, which affects your collections.

Taking a client-centered approach can also make a big difference. Building strong relationships and maintaining open, consistent communication with customers often leads to better payment habits. Over time, this can help reduce the costs associated with collections. By focusing on these strategies, you'll streamline operations and strengthen your business's financial stability.

Why should I compare Best Possible Days Sales Outstanding (BPDSO) with actual DSO, and how does it help improve collections?

Comparing your Best Possible Days Sales Outstanding (BPDSO) to your actual Days Sales Outstanding (DSO) is a great way to uncover inefficiencies in your collections process. BPDSO represents the ideal timeframe for collecting payments, while DSO reflects the reality - how long it’s actually taking. A significant gap between these two can point to problems like delayed invoicing, weak follow-up efforts, or overly flexible payment terms.

Regularly monitoring this comparison can help you spot opportunities to optimize your process. For instance, you might refine your collection strategies or adjust payment policies to close the gap. Taking these steps not only shortens your DSO and boosts cash flow but also fosters stronger customer relationships by promoting timely communication and setting clear expectations.

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