Well, any business entity even how "small" you are as long as you are extending credit must have some sort of financial controls, over a certain accounting periods to recover the funds you invested in your accounts receivable. This is important to monitor for you to pay also your financial obligations or better yet to be able to reinvest the same, which may increase your profits or income. Lets face it, whether you know it or not, you are directly or indirectly capitalizing your debtor by financing its business through your credit line and if ever this debtor of yours failed to pay you back in the agreed credit term, you are going to need more capital to further finance your accounts receivables.
There are many ratios that you could use to monitor the effectiveness and efficiency of your credit and collection department. First, there is the:
Collection Percentage Index. Formula:
Collection Made During the Period ÷ Receivables Outstanding at the beginning of the period = Collection Index.
Plot the collection percentages on a chart and you will be able to see the general trend in collection as indicated in the resulting curve. When the collection are unfavorable, remedial collection efforts maybe undertaken; and to determine extraneous causes of unfavorability of collection.
Second, you could also measure the: Average Collection Period.
This is a similar measure to the collection index that estimates the average length of time that receivables are uncollected. It is arrived at by dividing the number of days in the credit term, allowed by the term of sale, by the collection index, thus;
Net Credit Period ÷ Collection Index x 100 = Average Collection Period.
The collection arrived at is deemed the effective credit term. Like all averages it does not necessarily indicate the actual experiences upon which it is computed. It may be possible that not all of the accounts receivable is collected in full as of certain date but may follow each other past the credit term. Nonetheless as in all averages it is significant and good measure of the collection efforts and of the accounts receivable quality. (To be continued)
SEMINAR INVITATION: CIBI will have a SEMINAR ON CREDIT & COLLECTION FINANCIAL ANALYSIS, on May 4-5, 2006 at Cebu Midtown Hotel. Interested participants can call 412-2248/ 2310-480 .
Editor's Note: Mr. Ed F. Limtingco, is the VisMin Manager of CIBI Information, Inc., a business information and receivables management company. He can be reached at 0917-7220521 or at elimtingco@cibi.net.ph