Forget About the Outer Rings, Target the Bull's Eye
CreditForce is well known for being a leading credit, collections, risk, and query management suite. One of its key features is its intelligent algorithms for setting optimum Collections targets. This paper provides some information about the algorithms used, and why they are useful. Over the years we have asked our clients how they set collections targets. Their responses have been interesting. Within most commercial organisations, the debt position is looked at jointly with the collections team and a target for the period worked out, frequently set on the basis of a percentage of the debt outstanding at the beginning of an accounting period. Most will set a DSO (Days Sales Outstanding) figure as target. Many companies will also set daily targets, generally by simply dividing the target for the period by the number of working days in the period. There can be further sophistications introduced such as basing the daily target upon the actual collections on the same day in the previous year expressed as a percentage of the collections for the period as a whole, and then applying this percentage for each day to the target for the current period e.g.: “1.3% of the collections for the month were collected on Tuesday 9th August, so we will assume the same percentage of the current year target for August will be received on the 9th also." Whilst this “finessing” is potentially useful, it does not take into account changes in client mix, product or service delivery, and payment behaviour.
Professional Services and Law Firms
Clients from this sector often do not set targets. If they do, the majority are set by the accountants working out the cash requirements for the next accounting period, and adding a percentage. Some will set the target based upon reducing DSO, e.g. calculate last month’s DSO, and work out what needs to be collected in order to reduce it by e.g. 1 day. Others will set targets by office, practice area, and partner – forgetting that multi-matter and inter-office bills, especially if these comprise a high value of the receivables lead to the dilution of the target incentive. The purpose of the target should be to enable an individual to take responsibility for its achievement. It is not unusual for international firms to raise a bill for 6 matters, each for a different practice area, a different partner, and maybe even a different office, further complicated by time booked by staff working in overseas offices. The simple approach of assigning responsibility for debt in the same way as responsibility for achieving fee revenue targets does not work under these circumstances, and needs to be rationalised so that across the board the target can be linked to one person, responsible for its collection, at partner, practice area, and office level. CreditForce makes this adjustment automatically in target calculation.
So, Just how should Collections Targets be Calculated?
In our view, the method has to fairly reflect an organisation’s financial policies and business rules. If clients are granted credit terms, then all invoices which are due or past due are, by definition, collectible, and therefore legitimate for inclusion in a collections target. After all, the primary role of the credit control function is to ensure that clients pay their debts in accordance with the credit terms you have granted. Targets should be “motivating”, and achievable. If they are so unrealistic that they cannot be met, they may have the opposite effect. But they should aim to calculate the maximum potential “score”, the bull’s eye, and not one of the outer rings. Innovation Software’s CreditForce calculates collections targets for each credit controller, manager, product group, and office automatically. Algorithms are used for calculating each. The target is found by summing, for each account for which the collector is responsible:- Target = (the total due at the beginning of the collection period) + (all transactions falling due by the end of the period) + (forecast element) - (adjustment elements – see below) The total outstanding at the beginning of the period plus falling due is self-evident. But why does CreditForce also provide a facility for you to include a forecast element into the target? This is to enable you to include:-
potential sales arising during the current period made to customers whose accounts have credit periods of less than 30 days.
Invoices in dispute, that collectors cannot be expected to collect.
Invoices that are in dispute, but will be at the end of their SLA or Average Resolution Period, and falling due prior to the end of the accounting period.
Invoices in “payment by instalment” plans etc. (a full list is set out below).
Disputed invoices might have “Agreed Resolution Periods”, what we refer to as “Service Level Agreements” (SLA) that expire before the end of the accounting period, in which case the target should be adjusted upwards. We also calculate the average resolution period (over a user-defined time frame) by Customer, Dispute type etc. and will use this in the forecasting the data upon which the invoice or disputed amount will be paid instead of the SLA days. Targets will also be affected by settlement discount, in that if the settlement discount is taken, the target will be reduced.
Track and Drill Down for Detailed Explanation as to How the Elements are Moving
Having first calculated the target, we then shift “below the line” and track precisely how it moves, calculating and following each element as it changes throughout the period. This will include, for example, when invoices that were in the target at the beginning of the period are put into query, and the agreed resolution period / SLA does not expire until after the period end, and settlement discount that has been released, because a customer has not paid within the qualifying period.
Analysis of Total Portfolio of Debt as at the Beginning of the New Accounting Period
The following table shows the different elements comprising the debt portfolio and adjustments to arrive at the target, and elements of debt that should subsequently be tracked so that collections are maximised:-
After adjustments, the target is £ 68,000,000. It is useful to understand how the target changes during the period. This should be looked at on a daily basis. Some of the changes will mean that the target cannot be met. Other changes, on the other hand, represent opportunities for the amounts to be collected within the current period. Examples of such changes are as follows:-
We think this approach of use. It is rigorous, and the changes in each component of the target can be identified, and drilled down to for detail, as they take place. It also provides a clear picture of what to focus upon collections-wise if you need to “step up the pressure” during the period, and strategically. Most businesses will benefit from a thorough review of the causes of queries and disputes, and setting and progressively reducing SLA’s. Those offering settlement discounts will generally benefit by reminding their customers of transactions due within the early settlement period, and that it is no longer available, once the early settlement period has passed. It provides a number against which the cash requirement for the accounting period can be compared. If it is lower than the cash requirement, the CFO will know immediately that you have to do something else rather than just rely upon collections to bring this in – because, according to the business rules and policies, the probability of achieving this will be remote, if not impossible. From the earliest moment, finance directors will be able to see whether their cash requirements for the current accounting period will be met. It also sweeps up all “old debt”, which is the bane of most credit control manager’s lives. And so, we arrive at the definition, and design, of the perfect target – entirely capable of explanation, and reflecting the maximum a collections team could score – aiming for the Bull’s Eye, and not the outer rings.