A recent blog we discussed Days sales outstanding (DSO), a common calculation used to determine the health of a company’s accounts receivable. In that blog it was pointed out that that DSO, while it is an important metric, it alone is not an accurate representation of your accounts receivable success or failure. DSO should never be the end-all be-all of a company’s A/R checkup. Other accounts receivable metrics and trends should be analyzed along with DSO, including average days delinquent (ADD) the topic of today’s article.
What is average days delinquent (ADD)?
Average days delinquent (ADD) is the average day’s invoices are past due, the amount of time between invoice due date and the date it is paid. The calculation of this figure will help your company evaluate, along with other calculations, the overall performance of your collections department and your ability to convert A/R to cash.
- It is important to note that ADD is different from average days to pay because ADD looks at a snapshot in time while average days to pay is based on historical information and closed invoices.
How to Calculate ADD:
Before you can calculate your average days delinquent, you need to first do a few simple calculations.
Step #1 Calculate average Days sales outstanding (DSO)
DSO = (Average AR / Billed Revenue) x Days
Step #2 Calculate Best Possible DSO
Best Possible DSO = (Current AR / Billed Revenue) x Days
Step #3 Calculate Average Days Delinquent
ADD= Days Sales Outstanding – Best Possible Days Sales Outstanding
The result of your ADD calculation should be compared alongside your DSO. This will help create a more complete picture of both calculations and what they mean for your company’s finances and collections processes. A helpful way to visually see the relationship between these figures is to plot them on a line graph, but it is also acceptable to just look at the numbers.
If both ADD and DSO traveling up/down together:
This means that you can assume your credit and collections processes, depending on the direction of the line, are driving either the improvement of the downfall of your credit collections. If you see that both these numbers are dropping, you will want to look into ways to improve your processes to turn things around.
If DSO & ADD are moving in different directions:
This means that there is something else going on and you should absolutely take a closer look. For example, if DSO is rising while ADD is falling, the improvement in DSO was probably not driven by improved collection efficiencies; rather it may have been due to shorter A/R cycles or a change in credit terms.
Armed with these accounts receivable metrics, you can begin to evaluate where your company stands in terms of accounts receivable and begin setting goals for improvement. There are a number of different things you can do and small changes you can make to improve your metrics and overall process including:
- Developing or re-evaluating your credit policy.
- Standardizing your credit collections communications with templates.
- Making sure you have the right number of employees focused on the task.