Collections Efficiency Index (CEI): What It Is and How to Calculate It

Introduction

The collection effectiveness index (CEI) is a crucial metric used to assess a company’s ability to collect payments from its customers. It serves as an invaluable tool for monitoring a company’s financial performance. In today’s fast-paced business environment, maintaining a healthy cash flow is paramount, and the CEI provides insights into how effectively a company converts its receivables into cash.

However, the true power of CEI is realized when it is combined with days sales outstanding (DSO). While CEI measures the effectiveness of collections, DSO indicates the average number of days it takes to collect payment after a sale has been made. 

Together, these metrics offer a comprehensive perspective on a company’s credit and collections efficiency, highlighting areas of strength and pinpointing opportunities for improvement.

In this blog, we will cover everything you need to know about this metric – from its definition and calculation to how to interpret and improve it. Let’s get started.

What Is the Collection Effectiveness Index?

Collection effectiveness index is a popular metric across industries that gives the Order to Cash leaders a better understanding of how their A/R teams perform. The collection effectiveness index can be simply defined as “the percentage of account receivables that are collected in a given period.”

The CEI provides a clear understanding of the performance of the Credit and Collections teams. A higher CEI indicates that the organization has a strong credit policy and an effective collections process.

This metric helps organizations identify potential issues in their collections process, streamline their operations, and ultimately improve cash flow. By regularly monitoring the CEI, businesses can ensure they are maximizing their collections efficiency, reducing the risk of bad debts, and maintaining healthy financial stability.

Formula for Calculating Collection Effectiveness Index

Collection effectiveness index is calculated by dividing the beginning AR balance + monthly credit sales – ending AR balance by the sum of beginning AR balance + monthly credit sales – (ending AR balance x payment term/30). It gives insights into a company’s collection practices and financial health.

By considering both the AR balances at the beginning and end of the month, along with the monthly credit sales, this metric helps businesses identify areas where improvements can be made to optimize cash flow and reduce the time it takes to collect payments.

Breaking down collection effectiveness index

Let’s define the terms used in the formula

• Beginning receivables is the amount in account receivables at the beginning of the period.
• Monthly credit sales are how much money is made via sales in a particular month.
• Ending total receivables is all open receivables, including current and overdue ones.
• Ending current receivables is the total of payments you received for credit sales made during the period.

Collection Effectiveness Index Example

Now, let’s further simplify the calculation of collections effectiveness index with an example:

For example, if a company has $6000 in receivables at the start of the period, with monthly credit sales as $4130, ending current receivables as $4000 and ends with $6200 in total receivables, then its CEI is calculated by plugging these values in the formula shared above

• Beginning receivables=$6000
• Monthly credit sales=$4130
• Ending total receivables=$6200
• Ending current receivables=$4000

The CEI would be 64%.

To make it easier for you to calculate the collection effectiveness index we will be sharing the calculator in the next section.

Collection Effectiveness Index Calculator

As you evaluate your collection effectiveness index, consider it a starting point for refining your collections strategy. Next, focus on implementing best practices tailored to your business needs. From enhancing invoicing processes to offering flexible payment options, incorporating B2B Collections Best Practices can empower you to strengthen client relationships and streamline your collections efforts.

Understanding the Importance of Collection Effectiveness Index

1. Clarity on your payment collection practices

The CEI is a crucial key performance indicator (KPI) that quantifies the strength of your payment collection system. A lower CEI prompts upper management to recognize the need for significant adjustments in the credit and collections teams’  day-to-day operations. It helps to understand the importance of collection efficiency.

2. Timely assessment of your collection policies

The CEI is a tangible key performance index for understanding the effectiveness of your collection efforts.You can use the CEI formula to examine the quality of your collection efforts every month or to assess the quality of your collection efforts over longer periods.

How to Interpret Collection Effectiveness Index?

Now that you know that CEI is an important metric, it is an indicator of your collectors’ performance; learning how to interpret it correctly is essential. What if your collector’s efforts are not translating into a good CEI? Let’s look at a few parameters that might be responsible for the exception:

1. Incorrect or delayed invoicing

Would a customer pay if the invoice was not received on time or if the invoice data were incorrect? They might not. It is essential to track and double-check invoice information before contacting the customer.

2. Weak credit policies and lenient payment terms

Flexible credit practices and lenient payment terms could result in a low CEI. Customer payment behavior should be used to create various customer segmentation buckets and every customer segment should have tailored credit and collection policies.

3. Absence of flexible payment formats

Customers might have diverse payment preferences, and you need to address their unique payment preferences. The absence of flexibility in payment options might impact cash collection schedules.

4. Lack of customer portfolio prioritization

• Collection strategies
  Do your credit and collections analysts spend considerable time each day determining their call priorities? Often, collectors face challenges due to inadequate customer prioritization, resulting in calls to the wrong customers and payment delays.
• Reactive collections practices
  Typically, credit & collections analysts contact customers or send payment reminders only after invoices become overdue. Ideally, they should proactively issue reminders as the due date approaches rather than waiting for payment delays to occur.

How to Improve the Collection Effectiveness Index?

Understanding collection effectiveness index and computing it consistently will help you figure out what you might need to modify in your collections practices.

Based on the patterns of how CEI is changing across months or quarters, you would be able to come up with a strategy on how to improve your collections strategies. But as a beginning point, every AR team should consider, the following: 

Electronic workflows and escalations

Implement structured workflows for managing outstanding invoices based on:

• Aging Buckets: Categorize invoices by age to prioritize older, more urgent accounts.
• Call Summary: Keep detailed records of all communication with customers.
• Customer Payment Behavior: Adjust collection strategies based on the customer’s payment history and patterns.

Additional layer of customer experience

Enhance the customer experience during collections by:

• Recalling Previous Interactions: Be aware of past communications to provide a personalized approach.
• Reaching Out to the Right Person: Ensure that communications are directed to the individual responsible for payment processing within the customer’s organization.
• Researching Customer Background: Understand the customer’s business and financial situation to tailor your approach.

Manage delinquent accounts properly

Increase efficiency in managing delinquent accounts by:

• Sending Reminders: Regular reminders keep payments top-of-mind for customers.
• Automated Notifications: Use automated systems to send payment notifications and reduce manual workload.

Multiple Payment Formats

Encourage timely payments by offering flexible payment options:

• Online payments: Simplify the payment process with easy online payment options.
• Incentives for early payments: Offer discounts or other incentives to customers who pay early.
• Progress payments: Introduce partial payments based on project milestones or delivery phases.

Invoice Management

Ensure effective invoice management to avoid delays and disputes:

• Tracker for on-time delivery: Implement a tracking system to ensure invoices are delivered promptly.
• Proof-reading of invoices: Check invoices for accuracy before sending them out to prevent errors that could delay payments.

Strong Credit Policies

Design robust credit policies tailored to customer behavior and payment patterns:

• Based on customer behavior: Adjust credit terms and limits according to the customer’s reliability and payment history.
• Customer payment patterns: Analyze payment trends to refine credit policies and set appropriate credit limits.

Wrapping Up

In summary, enhancing your collection effectiveness index involves optimizing your credit and collections process. One effective way to achieve this is by leveraging an order to cash software. Such solutions streamline collection processes, ensuring timely follow-ups, reducing manual errors, and improving overall efficiency. 

By automating key tasks, you can significantly boost your CEI, reflecting a more effective and efficient approach to managing receivables. This streamlined method not only improves your financial health but also supports better decision-making and resource allocation.

FAQs

1. What is a good collection effectiveness index?

A good collection effectiveness index indicates that an organization is effectively managing its accounts receivable (AR) and collecting payments in a timely and efficient manner. A generally accepted benchmark for a good CEI is 85% or higher, anything below suggests collection issues.

2. What is the difference between CEI and DSO?

CEI measures the quality of a company’s collection process by calculating the percentage of receivables collected within a period, while DSO measures the average number of days to collect payment after a sale. CEI focuses on collection efficiency, while DSO focuses on the speed of collection.

3. What does CEI measure?

CEI measures the effectiveness of collection processes by calculating the percentage of receivables collected within a period. It reflects how efficiently outstanding receivables are converted into cash, indicating the overall health of accounts receivable management and cash flow of a business.

4. What is the Collection Efficiency Rate?

The collection efficiency rate (CER) measures a company’s collections efforts by comparing the total amount of outstanding receivables to the amount collected over a specific period. It is a quantitative assessment of how well a company manages its receivables and converts them into cash.