Is the policy working?

So you have a sound credit policy in place and are now using it to manage
your accounts receivables.  Now it's time to measure it's effectiveness.  How
do we accomplish this?  By simply monitoring the A/R from period to period
to see if there is an improvement.

Look at your accounts receivable aging and determine the percentage (%)
of accounts that are current and overdue in each column.  It should look
something like this:
 Total AmountDue Current 1 to 30Past Due 30 to 60Past Due 60 to 90Past Due 90 +Past Due 22,318,846 18,914,219 1,557,586 513,415 248,782 1,084,846 100% 85% 7% 2% 1% 5%
Now, you need to examine the percentages of total A/R that are past due
and in which columns they fit.  In the above example, we can see that a
full 5% of total receivables is past due by 90 days.

The next step is to determine WHY these receivables are past due.  Are
they amounts owing from sister companies (inter-company) that have not
been offset with the A/P department?  Are there products that are not
being paid for because the customer wants to return them?  Are there
pricing disputes?  Or, are these legitimate past due amounts that are
owed?  One thing is for sure, you can not deal with problems until you
have identified them.  Scrub the A/R.  Eliminate minor disputes and billing
errors and focus on the past due accounts!  The longer a balance
remains past due, the more difficult it is to collect.
Days Sales Outstanding

If you reviewed our Analysis Pages, you may have familiarized yourself
with the term "days sales outstanding" and how it relates to the efficiency
of a business.  Days sales outstanding, or "DSO", simply refers to the
number of days it takes to "turn accounts receivables into cash".
Obviously, the shorter the time period the better.
Calculating DSO

The formula for calculating DSO for collection purposes is:

A/R Balance                       x Days in Period = DSO
Net Sales for Period

If we take the total A/R as shown on the above aging report, and divide
that by the net sales for the period and then multiply that by the number
of days in the period, we can determine our DSO for that length of time.

For example:

22,318,846        x 90 Days = 51 Days Sales Outstanding
39,674,955

In the above example, we are suggesting that sales period was 90 days,
or...if a company starts it's fiscal and sales year on January 1, this would
be for the first fiscal quarter (ending March 31).
How does this help us?

The key here is trend analysis.  You must compare your results from
month to month, quarter to quarter and also year to year.  If you find that
the A/R aging balances are increasing in the past due columns, you
know that your department is heading in the wrong direction.  Again, set
goals!  The same is true for DSO; set a goal of reducing your DSO from
period to period.
Summary

Monitoring the A/R and calculating DSO are just two ways that finance
managers "keep score".  As part of your formal credit policy, you should
have clearly defined, realistic goals before your fiscal year starts.  This
should done in conjunction with the sales goals of the organization and
take into account any changes in payment terms that management may
be considering.
How do we keep our DSO from growing?

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