Whether you work for a contractor, a material supplier, an architect, etc., we all depend on our customers to pay us back for services or materials we’ve already provided. You may have a general sense that collections are going well when you have enough cash in the bank to pay your bills, but how do you measure your performance and continue to improve?
As the credit manager for Frensco Building Products, my team uses a variety of KPIs that tell us exactly how well our credit, collections, and accounts receivable efforts are going. In this article, I’ll explain the metrics we track, what each one can tell you, and how to use each KPI to keep getting better.
In the immortal words of Salt-n-Pepa: “Let’s talk about A-R-T, let’s talk about C-R-V. Let’s talk about all the good things that they bring.” Let’s talk about KPIs!
Related: What does a credit manager do?
What is a KPI?
A key performance indicator (KPI) is a performance measurement used to evaluate success, whether for an individual, a team, or a company. Just about anything you can measure can be a KPI.
Think of it like sports stats: You can compare two baseball players by looking at their runs batted in (RBI) or number of errors — these are both KPIs.
KPIs support healthy competition, both between team members and against your own past performance. My credit team takes pride in reviewing monthly KPIs. Of course, reviewing performance is fun when a team or individual is successful; it doesn’t feel as rewarding when numbers are declining. But your failures aren’t anything to be afraid of — in fact, a downward trend in your success metrics can be a powerful learning tool.
I don’t to bore you with all the different types of KPIs (there is a virtually endless number of them), so this article will dig into some common KPIs that a credit professional should track to make sure you are making the necessary adjustments, decisions, and risks to fulfill your company’s needs.
So read on (and then put them into practice)! Let the fun and magic begin.
12 metrics to measure credit & collections
How can you lead a team or lead yourself if you are not checking to see if your efforts are working? Have you developed KPIs for your team? Are you reviewing them monthly, quarterly, and/or annually? Metrics are important to keep your team on track to be a highly successful force.
Some quick things to remember:
- Current receivable = a receivable that is not due yet.
- Total AR = the total of receivables that is due to the company which includes invoices due, not due, and past due. So, Total AR = invoices not due + past dues
These figures are obtained from running your company’s aging report. This report contains the total invoices booked per day or month depending on the day you run it. This report distinguishes your receivables into buckets (Current, 1-30 days, 31-60, 61-90, 90+). These aging buckets are standard, but you will see some variations from company to company.
Below are 12 of the most common KPIs used in construction credit operations. You can generate most of these automatically from common construction accounting software platforms, like Quickbooks or FoundationSoft. The formulas are also included below in case you need to calculate them manually.
You can generally get the figures used to calculate these KPIs from financial statements, accounts receivable records, and sales data.
The first seven measure success in credit and collections:
- Current Percentage
- Days Sales Outstanding (DSO)
- Bad Debt
- Monthly Sales
- Collection Effectiveness Index (CEI)
- Accounts Receivable Turnover (ART)
- Average Days Delinquent (ADD)
The other five help credit professionals see the overall picture and make better credit decisions:
- Net Cash Flow
- Current Ratio
- Inventory Turnover
- Customer Lifetime Value (CLV)
- Gross Margin
1. Current percentage
Current percentage calculates the percentage of receivables that are current. Depending on the company’s goals and size, this percentage goal is what you strive to meet each month.
Formula: Current AR ÷ Total AR
A current receivable (or current AR) is a receivable that is not due yet. If your typical invoice terms are Net 30, your current AR is the sum of all invoices that are younger than 30 days.
Total AR includes the total of receivables due to the company. This includes current AR, plus invoices due and past due.
You can get these figures by running a company aging report, which distinguishes your receivables into buckets (Current, 1-30 days, 31-60, 61-90, 90+). This report contains the total invoices booked per day or per month depending on the day you run it. This report These aging buckets are standard, but you will see some variations from company to company.
If your customer base is made up largely of contractors, the current percentage may be lower due to contractor payments being much slower. Companies with a vast customer base and consistency may require a higher percent current. They expect the bulk of their customers to pay on time with no issues consistently. This metric should be tracked monthly to meet a company’s set goal.
2. DSO vs. best DSO
DSO Formula: (Accounts receivable ÷ sales on credit) x number of days current
Best DSO Formula: (Current receivables ÷ sales on credit) x number of days in the period
Days Sales Outstanding (current and past due invoices) and best Days Sales Outstanding (current invoices) determines how long it takes the company to receive payment. Use the calculation to measure your performance and check for patterns and Best DSO. This helps you determine if you are collecting quicker or slower each month.
The difference between the two calculations tells you the following:
- A negative difference means collections are better than best DSO.
- A positive difference means collections are the same or slower than the Best DSO.
Read more: How to transform DSO in construction
3. Bad debt
Bad debt is the sum of all outstanding invoices that are considered uncollectible, meaning that you don’t ever expect to get paid for them. Track any sales that you consider uncollectible on a monthly, quarterly, or annual basis.
A low bad debt balance can be a positive or negative thing: It could indicate that you’re not taking enough risk (and could be making more sales), or that you are simply doing the necessary tasks to prevent bad debts.
A high bad debt balance could mean the company is taking too much risk to obtain business. Each company is responsible for determining their own level of risk, and you cannot compare companies’ risk levels to one other.
The following tasks are helpful in preventing bad debts:
- Running all customers through a prequalification process
- Recognizing red flags in customer conversations
- Performing annual file reviews
- Protecting and enforcing your mechanics lien rights
- Reducing credit line exposure for non-active customers
4. Monthly sales figures
Monthly sales (obtained from income statements) are good to monitor, since monthly sales affects monthly metrics. A low sales month affects current percentages in a negative way. A higher sales month typically makes credit professional metrics perform at the top of their game.
It is important to keep a consistent check on sales each month so that you do not allow slow or strong sales months to distract your work.
5. Collection Effectiveness Index (CEI)
Formula: Beginning Receivables + Monthly Credit Sales – Ending Total Receivables
Construction companies measure Collection Effectiveness Index to evaluate the collection staff’s ability to collect funds from their customers. This is a metric that some believe is more precise than daily sales outstanding (DSO), since it shows the collection efforts from all available receivables from a specific period.
6. Accounts Receivable Turnover rate (ART)
Formula: (Sales on credit – Sales returns – Sales allowances) ÷ Avg Accounts Receivable
A company’s Accounts Receivable Turnover (ART) rate measures the number of times over a given period that they collect the average accounts receivable. This metric helps with financial and operational performance.
A higher ratio shows a high performing collection team with a strong customer portfolio that pays bills timely, and a lower ratio indicates either a riskier customer portfolio or a need for improvement for the collection team.
7. Average Days Delinquent (ADD)
Formula: Regular DSO – Best Possible DSO
Average Days Delinquent (ADD) is the average amount of days to get an invoice paid. This metric helps evaluate the collections performance and the ability to convert AR to cash. This metric, along with DSO, helps a team see the big picture of collections performance.
8. Net cash flow
Formula: Net cash flow from operating activities + net cash flow from investing activities + net cash flow from financing activities
Net cash flow is the amount of cash generated or lost over a period. A company that consistently performs with positive net cash flow shows they are strong and can be successful over time. A company that consistently shows negative cash flows indicates problems with operations or financial issues.
A company can be growing too fast or acquiring companies that are using up the cash needed to keep the company flourishing. Remember this metric should be used in conjunction with other metrics not by itself to determine viability.
9. Current ratios
Formula: Current assets ÷ Current liabilities
Current ratios show a company’s ability to pay short term obligations due within a year. Credit managers efforts in collecting funds directly affects cash flow for a company to pay debts, payrolls, buy new products, etc.
10. Inventory turnover
Formula: Cost of goods sold ÷ average inventory
Inventory turnover determines the number of times in each period a company must replace inventory it sold. This ratio helps businesses make better pricing, manufacturing, marketing, and purchasing decisions. Also allows you to manage sales and control cost.
11. Customer Lifetime Value (CLV)
Formula: (Customer revenue per year x relationship years) – total cost of acquiring and servicing the customer
Customer Lifetime Value (CLV) measures the total dollar value that a customer is worth to your company for the whole time they have been doing business with you.
It is important to know the value of a customer over the entire relationship. As credit professionals, our customer service can nurture and facilitate continued growth for the company. It is cheaper to maintain and grow with existing customers so why not assist sales with that. Remember we are also sales team members. We close the deal!
12. Gross margin
Formula: ([Net sales – COGS] x 100) ÷ net sales
Gross margin measures sales revenue after consideration of the cost to produce the goods it sells and servicing the customer. It is normally expressed as a percentage.
A higher gross margin reflects the more funds available to use elsewhere in the company to pursue new products, purchase new companies, or satisfy obligations.
Use the KPIs that work for you
This list of KPIs is just a small snapshot of metrics that can be used to measure your success. Credit professionals use a variety of tools to find more ways to assist the sales teams and their company’s growth plans. Let us continue to share, educate, and grow together!
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