Optimum Collection Efficiency

Don’t complicate B2B collection

I was fortunate to fall into Credit Management having spent my early years in what was then called Electric Data Processing (EDP), working with mainframe computers and associated programming;  the early days of ERP systems therefore.

This gave me a deep rooted understanding of accounts receivable, accounts payable, accounting, finance, payroll, manufacturing  and costing, many of the essentials therefore of understanding how a business is run and managed.

I did not however need a degree in human psychology to collect money from B2B clients and neither did I ever have a problem in achieving what I call optimum collection performance, not as required, but as achievable given the specifics of the business and how it was run. And herein lays the issue.

Knowing how businesses engage in business, knowing the intricacies of managing a business and how organizations work internally and above all, knowing the industry sector one is working in is vital to managing receivables successfully.

Optimising collection and measurement of its effectiveness has traditionally fallen to somewhat inaccurate measures such as DSO (days sales outstanding), DPD (days past due), or CEI (collection effectiveness index). While any measure is better than none, inaccurate measures can equally be harmful and can present a wholly presumptive position.

Inaccuracy of these traditional measures is affected by many factors, the timing of month end cut-off, the varying terms granted across clients, inter group or associated sales, cash or prepayment trade, early settlement discount trade, credit balance accounts, sale or return billing, the value of credit notes processed in the month, efficiency of dispute management and also the company policy on bad debt write off. Throw into the melting pot the fact that many businesses invoice heavily in the last week of each month or hold back certain credit notes and a picture emerges.

Given all these factors and others, one can see that considering any form of traditional measure without taking these into consideration and working on a monthly, weekly or daily invoice date based receivables report, becomes meaningless.

Using a receivables report aged on the basis of ‘due date’ however, eradicates the issue of varying terms across accounts and the vagary of heavy billing toward the period close but still leaves one having to contend with other variables.  It nonetheless offers a firmer foundation on which to begin measures and factor in the variables.

Collectable debt is the key measure one should be look for in setting cash targets for the coming period and the measurement of current debt along with past due debt carries infinitely greater meaning in the context of collection efficiency and vastly improves cash flow forecasting accuracy and consistency.

Collectable debt based on due date allows one to focus entirely on precisely this; deducting sale or return billing, adding back credit account balance values and removing insolvent account balances or bad debt not yet written off. Adjustments should be made accordingly to each respective aged receivable column. Disputed account balances should be treated as collectable. If they are with third party collectors or in litigation, they should however be treated and provided for as a bed debt.

Creating or segmenting variable due date aged receivables reports based on terms or size of client/debt can supplement and add to the accuracy of cash flow forecasting and collection efficiency.

Using a due date receivables ledger provides for greater consistency even in standard DSO measures but don’t just limit it to a DSO measure of the total ledger balance, work DSO for the current balance value and also another to the total past due value.

Getting the right collectors working on the larger accounts which generally can account for more than 70% of total receivables, encouraging or inducing as many of your smaller to medium sized clients to pay by direct debit and getting pro-active calls in to your clients will set a pattern or recognized activity and client response.

Collection of amounts due from significant clients where transaction volumes are high is not collection per say, but sales account management and administration, ensuring as many of those invoices payable are included into their payment run. Encourage relationship building allowing your senior collectors to visit in either, collecting cheques, dispute resolution, problem solving or general account administration. Such relationships and collaboration, even at this level, yield massively increased efficiency and greater surety of payment.

In my early days the telephone was the foremost and most effective collection tool. One knows when one called, who one spoke to, what was promised and when and a follow up was so simple if the promise was not met.

Despite the relentless march of technology and the numerous new aides to collection, I still feel the telephone, properly used, represents the best form of collection tool available.

Collectable debt, once you have isolated and improved dispute resolution and credit note issue to its optimum  and removed other variables provides greater leverage in achieving what I call ‘optimum collection efficiency’, in other words, a consistent point beyond which you simply cannot improve without materially affecting the ability of your company to sell and continue to grow.

Such collection efficiency may for example demand that you collect within the next 30 days, 95% of the total collectable debt knowing the other 5% will be subject to dispute or insolvency. There is nothing to say you cannot work to still improve these percentages but most variances will generally be driven by economic conditions and adverse trading, events often beyond the control of those in credit.

The ideal target is to achieve a measure of optimum collection efficiency (OCE) so that a graph of daily receipts over the month overlaid shows little or no variance one month to the next.

DSO and bad debt as a percentage of sales remain bog standard measures and I seriously question why this should be so. They are both subject to so much interference and objectivity; some manufacturers for example will only write off debt once it passes 360 days. To obtain any tangible value, DSO must consistently and uniformly factor in all variables and accurately so, with measures not restricted to just the overall total ledger balance, they must include current balance DSO and past due DSO. It’s time to standardize this measure in any event to give it any real meaning.

Restricting measures or optimum collection efficiency to just one monthly report will not provide the full picture of performance.  Consider weekly reports and review current position compared to expectation.

Some credit people talk of ‘educating’ clients in paying their bills on time. This is crass and really says nothing positive about clients and even perhaps questions ones approach to granting such ‘ignorant’ customers credit in the first place. Anyone in business selling or buying on open credit terms knows paying on time is a requirement and expectation. The adage that has always worked for me and any of my teams is check your client before and during trade, treat them as a client and not a debtor and ensure your company delivers on its promise. Clients are then far more likely to respond favourably and most frequently, often without prompt.

I recently read an article that suggested collectors should confine their client calls and approaches only to those in accounts payable and not sales, buying or even the financial director or managing director; the fear being they may say the wrong thing and damage a trading relationship.

While I can appreciate on occasion a measure of collection escalation, if any of my team were not suitably trained and equipped to manage calls across the client spectrum, I would have considered this a major failing. Being properly trained with a thorough knowledge of the client and knowing how and what to say to various divisions or structures within clients is crucial to efficient collection and incremental continued business. Who hasn’t spoken to a buyer expecting delivery perhaps with an engineer on site only to find it’s been held up by their finance team – guaranteed payment next day. Train and empower your collectors, avoid hierarchical collection and always back your collector when matters are escalated.

If you plan to use reminder letters, use just one, make it an effective final demand and use sparingly and only when the situation demands it; this way clients recognize the way you work and will know precisely the implication of receiving such a letter; if you threaten to litigate or withhold supply and don’t, you fail at the first hurdle. It’s infinitely better to use these sensibly and achieve a 98% success rate instead of firing them off randomly, only to see a low return.

View clients as dodgy people out to steal your goods and money and that’s probably what many of them will turn out to be. Occasionally, bad experiences do happen but one does not have to repeat them. Keeping good clients buying and paying on time is what this game is all about and despite the name we apportion to them once a sale occurs a client remains a client and not a debtor. A debtor is someone who will not pay, or is unlikely to pay and these surely should be a minority in anyone’s receivable ledger.

Cash flow remains the life-blood of business continuity and closing sales with payment remains a primary responsibility. Keeping the flow optimized and constant does not necessarily mean being singularly a ‘debt collector’, this is term one can easily and justly apply to lawyers and third party agents, not to those engaged and responsible for managing receivables generated from sales or services. I much prefer the term credit and customer services.