Collection Efficiency

Collection efficiency measures how quickly a company converts its sales into cash by collecting payment from customers. This working capital metric reveals the effectiveness of credit policies, customer quality, and the overall health of a company's revenue relationships.

Key collection metrics include:

Days Sales Outstanding (DSO):

DSO = (Accounts Receivable / Revenue) × 365

DSO shows the average number of days it takes to collect payment after a sale. For example, a company with $50 million in receivables and $365 million in annual revenue has a DSO of 50 days.

Receivables Turnover:

Receivables Turnover = Revenue / Average Accounts Receivable

Higher turnover means receivables are collected more frequently throughout the year. A turnover of 12 means receivables are collected monthly on average.

Why collection efficiency matters:

• Cash availability: Faster collection means cash is available sooner for operations and investment
• Reduced financing needs: Less cash tied up in receivables means less need for external financing
• Lower bad debt risk: Longer collection periods increase the probability of non-payment
• Working capital efficiency: Better collection improves the overall cash conversion cycle

Industry benchmarks vary significantly:

• Retail: Often near-zero DSO due to point-of-sale payment
• Software/SaaS: Typically 30-60 days with subscription billing
• Manufacturing: Often 45-90 days depending on customer relationships
• Construction: Can exceed 90 days due to project-based billing

Analysing collection trends:

• Improving DSO: May indicate stricter credit policies or improved collection processes
• Stable DSO: Consistent with historical patterns suggests steady operations
• Rising DSO: Requires investigation into underlying causes

Warning signs of deteriorating collection efficiency:

• Customer financial stress: Economic downturns often extend collection periods
• Aggressive revenue recognition: Booking sales before collection certainty
• Weakening business relationships: Customers prioritizing other suppliers
• Channel stuffing: Shipping products that may be returned
• Potential bad debt write-offs: Aged receivables often become uncollectible

Receivables growing faster than revenue is a classic red flag that often precedes earnings disappointments. Investors should monitor collection efficiency trends as an early warning indicator of business health and earnings quality.