If you use these measures, you are focusing on the wrong things and in turn this will cause you to get the wrong results. You should start with your aged ledger totals, split your accounts into their agreed terms: cash, payment due at the end on the month following invoice (normally referred to as 30 days), payment due at the end of the second month following invoice (normally referred to as 60 days), etc. Finally there can be some old balances where payment plans have been agreed and are being cleared as agreed.
When you total each of these categories you see how much of your ledger is within terms.
Balance Current 1 month 2 months 3 month+
30 Day 4,567 3,489 658 236 184
60 Day 2,163 857 941 104 261
Old Balances 758 758
Total 7,488 4,346 1,599 340 1,203
If we have performing payment plans for half the old balances, we know that on the first line €3,489 is within terms, on the second line (857+941) €1,798 is within terms and of the old balances €379 is within terms. That gives a total of €5,666 within terms out of a total balance of €7,488.
Divide the balance within terms (€5,666) by the total balance (€7,488) and multiply by 100 to give you your percentage and you will arrive at a figure of 75.7%, which tells you that over three quarters of your ledger is within terms. This is a useful measure to use on a month on month basis to monitor the effectiveness of your collection process. When this number is combined with your days sales outstanding that was explained in the last article you will begin to get a clearer picture of the performance of your ledger.
In this example there is 24.3% outside terms, it is a good exercise to work out what is the cause of this: is it made up by disputes and queries, is it customers who haven’t got the money to pay you, is it because of a poor collection system?
As soon as you get down to this level, you can begin to address the real issues facing your credit function and when you establish in real terms the reasons that is holding back your collections the sooner you can begin to address them. Then you need to get everyone to work with you to address the issues as a matter of urgency. You will find that the issues you uncover will not simply be credit issues but issues that are affecting your customers and perhaps even your company’s image in the eyes of your customers.
If more senior managers looked more deeply into their own debtors ledgers they would discover a host of areas within their own business that should be improved and addressing these issues will have a positive impact on the whole business.