The credit department and its personnel can be essential to helping a company increase sales, meet corporate goals, and enhance cash flow—but often get overlooked or even ignored as part of the operational process in achieving these critical business elements.
One way credit personnel can help their organization or company is to incorporate various measurements and metrics to review the effectiveness and efficiency of the credit department. In the produce industry, companies often fail to take advantage of available performance metrics to identify areas where credit functions can be of more value.
Measuring the Effectiveness of Credit Functions David Vaiz, credit services manager for Driscoll Strawberries Associates, Inc. in Watsonville, CA believes it is imperative to incorporate performance metrics: “The credit department is responsible for one of the key assets of our company, accounts receivable. Measuring our effectiveness helps to ensure that we’re minimizing the company’s credit risk while promoting sales.” Further, he notes, “I strongly believe you can’t improve what you can’t measure.”
Riverhead, NY-based Charles Brown, credit manager for Hapco Farms, LLC, concurs. “Because accounts receivable is such a large asset of our company,” he explains, “I monitor every account on a weekly basis and numerous accounts on a daily basis.”
Credit departments can also play a role in helping a company grow. By evaluating the most successful accounts, patterns can be identified and used to solicit new accounts. Additionally, determining what accounts you want to retain as customers can help fuel profits.
Key Performance Measurements To help monitor accounts, a relatively standard tool is days sales outstanding (DSO), which helps measure the liquidity of accounts receivable relative to credit sales on an annual basis. To arrive at your DSO, divide accounts receivable by annual sales, then multiply this sum by 365 to arrive at the daily figure.
The DSO analysis provides an idea of the number of days, on average, customers take to pay their invoices. As a rule of thumb, the higher the DSO ratio, the more likely your overall customer base may have credit problems or that many of your customers have slower paying accounts themselves. Conversely, if you have an extremely low ratio it may mean your company’s credit policies are so tight they may be inhibiting possible sales.
Brown says Hapco uses DSO to help monitor trends on accounts and to ensure averages aren’t “going down to the point where it impacts our own cash flow.”
Understanding Trends Trends can be a key component to understanding your accounts. By monitoring DSO on a monthly basis, you can follow possible seasonality or “peak” periods when customer pay patterns may vary. For example, if a company has traditionally shown a lower DSO in summer months versus winter months, you can better prepare your cash management knowing an account may be a bit slower during certain points within the year.
The credit department and its personnel can be essential to helping a company increase sales, meet corporate goals, and enhance cash flow—but often get overlooked or even ignored as part of the operational process in achieving these critical business elements.
One way credit personnel can help their organization or company is to incorporate various measurements and metrics to review the effectiveness and efficiency of the credit department. In the produce industry, companies often fail to take advantage of available performance metrics to identify areas where credit functions can be of more value.
Measuring the Effectiveness of Credit Functions David Vaiz, credit services manager for Driscoll Strawberries Associates, Inc. in Watsonville, CA believes it is imperative to incorporate performance metrics: “The credit department is responsible for one of the key assets of our company, accounts receivable. Measuring our effectiveness helps to ensure that we’re minimizing the company’s credit risk while promoting sales.” Further, he notes, “I strongly believe you can’t improve what you can’t measure.”
Riverhead, NY-based Charles Brown, credit manager for Hapco Farms, LLC, concurs. “Because accounts receivable is such a large asset of our company,” he explains, “I monitor every account on a weekly basis and numerous accounts on a daily basis.”
Credit departments can also play a role in helping a company grow. By evaluating the most successful accounts, patterns can be identified and used to solicit new accounts. Additionally, determining what accounts you want to retain as customers can help fuel profits.
Key Performance Measurements To help monitor accounts, a relatively standard tool is days sales outstanding (DSO), which helps measure the liquidity of accounts receivable relative to credit sales on an annual basis. To arrive at your DSO, divide accounts receivable by annual sales, then multiply this sum by 365 to arrive at the daily figure.
The DSO analysis provides an idea of the number of days, on average, customers take to pay their invoices. As a rule of thumb, the higher the DSO ratio, the more likely your overall customer base may have credit problems or that many of your customers have slower paying accounts themselves. Conversely, if you have an extremely low ratio it may mean your company’s credit policies are so tight they may be inhibiting possible sales.
Brown says Hapco uses DSO to help monitor trends on accounts and to ensure averages aren’t “going down to the point where it impacts our own cash flow.”
Understanding Trends Trends can be a key component to understanding your accounts. By monitoring DSO on a monthly basis, you can follow possible seasonality or “peak” periods when customer pay patterns may vary. For example, if a company has traditionally shown a lower DSO in summer months versus winter months, you can better prepare your cash management knowing an account may be a bit slower during certain points within the year.
As the CFO of a Los Angeles-based shipper/distributor who did not want to be identified puts it, “When metrics reflect something different than expectations, any anomalies must be investigated. If the anomalies reveal something significant, then the credit criteria must be examined for that particular customer. Perhaps a discussion with the customer may reveal a temporary situation or extenuating circumstances.”
Not every company is in a position to sell only to top paying customers throughout the industry. Often, growth and increased sales are a result of assuming increased credit risk. In these situations, using a metric to monitor those accounts can be beneficial. One such ratio is the ‘prior month’s past due collected’ ratio. The formula, current month’s past due age categories divided by the beginning receivables of the prior month will show you what has been collected this month on the past due amount. While this could be self-evident in this month’s A/R aging report, it doesn’t help you monitor your collection efforts.
Another way to evaluate effectiveness is to analyze the cost of the resources devoted to collections versus sales. The following relationship is similar to determining an organization’s “cost per employee,” but specifically shows the dollars spent in efforts to collect each dollar of credit sales. The formula is as follows (the higher the percentage, the better): department/credit personnel costs divided by credit sales.
Another straightforward tool used to determine credit department effectiveness is a review of the two most dreaded words for any business—bad debt. A simple calculation can reveal the accuracy of credit decisions relative to overall credit sales. This is found by taking bad debt, net of recoveries, then dividing by credit sales. The lower the percentage of dollars written off to sales dollars, the better!
Choosing the Right Measurement(s) Unfortunately, there is no one universal metric that every organization should use. Rather, you should consider whichever formula will help you understand your accounts, monitor their performance, and serve as a reliable guidepost for your collecting efforts.
According to Vaiz, every company should have “their own credit policy and philosophy in how they approach credit and collections.” Further, he explains, “the metric used should coincide with that policy and philosophy, and should convey whether credit is being managed according to it.” While Vaiz confirms there is no single magic number, he supports the use of metrics by emphasizing again, “You can’t improve what you can’t measure.”
Brown finds DSO a useful tool because “it helps communicate and explain to everyone within the organization how well the company is collecting its money, which provides a better framework for making management decisions.”
Brown referred to DSO as a precursor to ensuring a company’s ability to be financially flexible. At Hapco, he says, “If we encounter a situation where our sales manager is requested by one of our retailers to provide more products, our DSO can provide a snapshot of our own ability to pay more suppliers within their terms.” To explain further, he uses the following as an example: “If our DSO shows an average of 23 days and a supplier expects payment within 30 days, we know we have the financial flexibility to accommodate the additional sales.”
The right “blend” of measurements and metrics will be different for each company; yet metrics can be a valuable internal tool for businesses of all types and sizes to both communicate and monitor the effectiveness of collection policies and processes.
