What is Collection Effectiveness Index (CEI): Definition and Use Cases
What is the Collection Effectiveness Index (CEI)?
The collection effectiveness index (CEI) is an accounting metric that looks specifically at the efficiency and effectiveness of an organization’s accounts receivable collection process. In other words, it is a way to gain insights into how well a company collects customer payments.
How to calculate CEI?
Teams typically track their collection effectiveness index every month. The tracking process consists of the following steps:
1. Gather data. In the gathering data phase, you’ll need to find the four following accounting metrics:
- Cash collections. The Cash collections metric is the total amount of cash collected during the month or given period.
- Beginning receivables. This is the total value of outstanding accounts receivable (i.e., how much your customers owe you) at the start of the month.
- Credit sales. Not every customer buys with cash. Credit sales represent the total value of all sales within the month made on credit.
- Ending receivables. This is the total value of accounts receivable at the end of the month.
2. Calculate CEI. Once you've got the above data points, you can calculate CEI using the following formula: CEI = (Cash Collections / (Beginning receivables + Credit sales - Ending receivables)) x 100
3. Track and Analyze. Once you've calculated your CEI, all is not done. Rather, the true way to make use of CEI is to continuously track and analyze it throughout the entire fiscal year.
4. Take Action. Once you measure your CEI, it is important to take action to improve your collection effectiveness. To do this, you should first analyze the CEI metrics to identify areas of improvement. This could include identifying slow-paying customers or analyzing customer payment patterns and behaviors that can be addressed through better communication or incentives.
CEI vs. DSO
There are two main measures of accounts receivable effectiveness. The first is the CEI. The second is the Days Sales Outstanding (DSO). However, CEI and DSO focus on different elements and bring different perspectives.
Rather than looking at how well a company converts outstanding receivables into cash, DSO focuses on the time it takes to collect receivables. DSO uses a simpler calculation and is often used to provide a broader perspective than just one month. Also, DSO does not factor in cash collections, whereas CEI does.
How to improve CEI?
If you’re wondering how to improve the collection effectiveness index, there are a few steps you can take:
- Optimizing and streamlining your invoicing and billing processes. Don't let delays in your invoicing negatively affect your CEI. Instead, look for an AR automation solution that can streamline manual, paper-based tasks for your AR team.
- Offering incentives for early payments. Offering discounts to customers who pay early can motivate them to pay faster. Even a small discount can make a big difference in reducing the amount of time it takes for receivables to be collected.
- Improve your collection strategies. Look at ways you can prioritize collection efforts based on the aging of receivables. This ensures that accounts are not left behind and allowed to drag down metrics like the CEI.
Why is Collection Effectiveness Index (CEI) important?
I (Collection Effectiveness Index) is very important for several reasons. One of its key purposes is to analyze cash flow management. By using CEI, businesses can quickly assess how efficiently they are able to turn their outstanding receivables into cash, and identify any issues that may be causing delays.
Removing these bottlenecks can improve your collections' effectiveness and ultimately increase your cash flow. Investors and company leadership will also look at CEI to measure a company’s overall financial health and liquidity.
Companies that can effectively and quickly convert receivables to inflow are better capable of meeting their financial obligations and investing in growth, whereas a low CEI can reduce cash flow and negatively impact financial stability.
The collection effectiveness index can also guide decisions on operations, such as extending credit, selecting customers, and assessing risks. Customers who consistently pay on time contribute to a higher CEI, while those who pay less frequently may represent a higher credit risk. By tracking CEI, businesses can make better decisions for their credit-granting process.
In conclusion, the collection effectiveness index is an important metric that gives insight into how well a company's accounts receivable processes are working. By understanding what CEI measures, and implementing strategies to improve this metric, companies can create a more efficient and effective collections process that leads to improved cash flow and financial stability.