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Introducing the Operational Ratios to Controllables in the

Credit & Collections process...


Abstract
Credit controllers strive to reduce DSOs to have better working capital and timely returns to any organization
involved in economic activity, but both external and internal factors make it difficult to control the DSOs, more
often than not the so called credit controllers effort result in measuring and reporting rater than controlling the
DSO.
Due to the high importance of cash in running a business, it is in a company's best interest to collect
outstanding receivables as quickly as possible. By quickly turning sales into cash, a company has the chance to
put the cash to use again - ideally, to reinvest and make more sales. The DSO can be used to determine
whether a company is trying to disguise weak sales, or is generally being ineffective at bringing money in. For
most businesses, DSO is looked at either quarterly or annually.
To help these managers to really control and bring objectivity to a certain degree of impact that they can have
on DSOs, various ratios were developed during the study with respect to overdue, Accounts Receivables and
Sales namely Zi () ratio and Chi ( ) ratio.
This article will outline the strategy for segregation of channel partners and in turn help the credit controllers
with data / facts based decision related to their collections and ARs.
Introduction
As a wise consultant taught me many years ago, business survival is like breathing when you breathe in it is
like getting cash flow in, and when you breathe out it is like spending or investing in the cash flow. If you
breathe out and dont breathe in for some time, you die.
Credit and collections managers do their best to minimize bad debts (breath-in, but they lack metrics to be to
measure their progress against a reasonable goal. Although credit quality and collections efficiency both have a
direct impact on DSOs, so do various types of disputes and delays that are beyond these managers' control.
While DSOs do improve, it's tough for managers to receive the credit that they deserve for their hard work and
accomplishments, where the decision are subjective and out of experience. Owing to the sales growth pressure

from the BUs, credit controllers find difficult to control the DSOs as they dont have proper metric that could help
them to make decision objectively.
Existing Cash Flow Methods Dont Work
Most businesses use MRP/ERP systems that are not effective in providing value in the supply chain. Typically
these systems are configured by global mandate/requirement. Credit managers certainly work hard and are
motivated by core metrics.
Lack of Visibility
Unfortunately, many departments don't find that these metrics yield sufficient insight to merit the time required to
track them. According to the CRF only 52% of companies monitor average days delinquent and only 71% track
best possible DSOs compared to the overwhelming 97% that track average DSOs.
The situation is not likely to improve, given that increasingly lean credit and collections departments have even
less time to collect additional information. According to the CRF, 90% of credit managers say that "do(ing) more
with existing staff resources" is a "very" or "significant" challenge.
Introducing the DSO Control Ratios:
Clearly, credit & collections managers need a new metric, one that provides even more visibility into the specific
impact that credit and collections managers have on the receivables management process without requiring too
much additional effort. To address this need, we have developed the "DSO Control Ratios" performance
metric which will be explained in the following paragraphs..,
Days of Sales Outstanding (DSO) definition:
A measure of the average number of days that a company takes to collect revenue after a sale has been
made. A low DSO number means that it takes a company fewer days to collect its accounts receivable. A high
DSO number shows that a company is selling its product to customers on credit and taking longer to
collect money. Days sales outstanding is calculated as:

DSO Control Ratios:


These ratios tracks the number of days by which average DSO's could be reduced if the credit & collections
processes were optimally efficient.

The DSO Control Ratios addresses many of the key challenges associated with tracking average DSOs. Like
* Backs the impact of disputes out of average DSOs. Disputes have a significant impact on DSOs, but they are
more directly linked to flaws in the manufacturing process, administrative errors, and misunderstandings than to
inefficiencies in the receivables process. Given this, it's critical to exclude the impact of disputes that are not
related to the credit and collections departments.
* Factors out external delays. Credit and collections have no control over the Channel Sales or invoicing
processes. Consequently, the ratio is reported net of all days associated with mail and billing delays.
* Mutes the impact of the revenue biases, where applicable. Firms that use the classic average DSO equation
(gross receivables / annual net sales * 365) rather than backing out sales month-by-month find that rapid
revenue growth can distort DSOs.
Benchmarking Your Performance
The DSO Control Ratios and channel segregation will take slightly little more time to calculate than the average
DSOs metric, but the effort will be worth the time investment. We've developed an excel based sheet for
calculation of the same. The approach that makes the most sense for your organization will depend on the type
of information that is most easily accessible to you as well as the consistency of your payment terms and take
strategic decision.

The Segregation Strategy Grid:

Opportunity for Improvement


After calculating the DSO Control Ratios, the typical firm will find that there is an opportunity for improvement.
According to CRF and industry data (for Electrical and Electronic Manufacturing and supply Organizations), the
median number for AR to Sales Ratio us suggested to be within .259 and Zi () ratio and Chi ( ) ratio being
0.05 and 0.25 respectively. For example to for a year end DSO to be 55 days the Tau ()ratio at the year end
should be ~ 0.151 and similarly other two control ratios can be derived out which is depends on the type of
sector the industry is operating its business.
On the contrary.. presently situation is dealt by choosing to settle for inefficiency in the receivables management
system, CFOs are leaving money on the table. For each day that average DSOs are reduced, an amount equal
to the average daily sales times the cost of capital is lost. Also, given that many collections teams scramble to
reign in receivables before the end of each reporting period, the true average for receivables is likely to be
higher than what's reported, and the effective impact of DSO reduction is likely to be even greater.

A simulation study made using historical DOE(Design of Experiments) for an industry involved in Electrical and
Electronic Manufacturing and supply.. the following contour chart depicts various possibilities/combinations of
the AR, OD(overdue>60days) with respect to the DSO ( see figures below)

For 55 days DSO

For 65 days DSO

Best Practices
In addition to the above elucidated strategy and control measures, our research indicates that there are several
other levers available to companies that seek to minimize the size of their DSO Gaps by developing world-class
receivables management processes.
Credit automation
Time-poor credit professionals are burdened with many administrative activities that could be automated - from
the acquisition of financial, account, and credit data to the scoring of customer accounts. Fortunately, many
companies have testified that automation has a positive impact on financial metrics. For example, a recent CRF
study shows that 45% of respondents believe that credit scoring has actually had a positive impact on DSOs.
Best-of-breed credit tools store all data in a centralized database, which can be leveraged to achieve many
goals beyond DSO management. For example, data can be distributed to credit managers around the world to
eliminate unnecessary duplication, used to conduct analysis that improves the granularity of credit screens, or
drawn on to generate lists that help sales to pre-qualify customers / channel partners. Finally, credit automation
improves the consistency of the decision making process - and creates an audit trail for every decision.
Collections automation
Credit professionals may be burdened by administrative tasks, but their colleagues in the collections
department are drowning in them. Before a phone call can be made, the collector must spend time deciding
whether an account merits immediate follow-up, assemble and quickly review all relevant documents, determine
whether there has been a decline in orders or a slowing of payments, and check on the status of disputes.

World-class companies like Siemens and ABB are adopting automated collections tools that establish a calling
order, centralize all necessary account information and relevant documents, update professionals on the status
of disputes, and monitor accounts for events that forewarn declining credit quality.
Automation software can also help collectors to more quickly execute on their post-call responsibilities (e.g.,
follow-up letters, faxes, documentation, and reporting). This allows collectors to devote more time to the activity
that is most directly correlated with reducing DSOs: talking to customers.
Management by exception
Once credit and collections functions are automated, the next step for world-class organizations is to ensure
that a) the data is shared across processes, and that b) management receives immediate notification of issues
that merit their attention. This will allow both the CFO and senior financial professionals to "manage by
exception", rather than wasting time with the 80% of accounts that don't require their attention at any given
moment. Automated and integrated credit and collection tools should minimize management response time for
dealing effectively with problem accounts.
Broader Implications
As a credit & collections professional who is dedicated to continuous improvement, your priority will be to
monitor the DSO Control ratios and implement technology that will enable you to limit it. However, the CFO may
see value in rolling out parallel initiatives elsewhere in the organization. For example, it would make sense to
monitor the impact of disputes on DSOs over time, classify these disputes into categories that can be assigned
to various areas within the organization (e.g., manufacturing, billing, sales, goods return, logistics, etc), invest in
more efficient processes and/or technologies, and measure progress over time.
Conclusion
The research indicates that the receivables management process is rife with inefficiency. This finding prompted
us to develop a performance metric, the DSO Control ratios provide companies with fact-based insight into the
degree of inefficiency within their own credit and collections systems.
The key to improving performance against the DSO is to use the control ratios to facilitate the exchange of
empirical data across people and processes. Not only will these process improvements reduce DSOs and
capital costs, but they will have a significant impact on bad debt expenses and processing costs. It's clear that

there's value in making every effort to "control the controllables" - and make the credit and collections
processes as efficient and error-free as they can be.

Authors Affiliation
Sri B Badrinath is currently the Country Champion for Business Process Excellence specializing in Lean Sigma
and Business Process Reengineering at Schneider Electric Pvt. Ltd, Prior to this he was the Head of Lean & Six
Sigma Deployment in WNS Global Services Lt, a ITES Giant listed in NYSE (WNS) India. He had also been the
founder of Lean initiative with WNS. He has extensively worked on enterprise-wide strategic alliances for
Deploying BPR & Continuous Improvement Philosophies at various Business domain like BFSI / Airlines /
Supply chain & Logistics / Manufacturing etc., (Ex. British Airways, SITA, Virgin Atlantic, Sony, Hawk eye,
Aviva, (Norwich Union), Fdex, Concentra, Canter, Marsh, etc). He has won several award from IQPC Asia
pacific and Global for implementation of Lean/SixSigma/ Business Process Excellence in WNS. He is presently
a in the National Jury panel for IQPC India for Manufacturing domain. Sri B Badrinath has a B.S. in Mechanical
Engineering from the Vellore Institute of Technology (Univ, of Madras) and a fellow of PGPEx Management
programme instituted by Indian Institute of Management Kolkotta. For clarification and quires You may reach
Sri B Badrinath at Sri.Badrinath@in.schneider-electric.com