How to Analyze Trade Credit - Pt. 6

Let's now build together another indicator that is perhaps a little less known: the CEI, or Collection Effectiveness Index for Anglophiles, which provides very interesting data regarding company performance in credit management , given by the ratio between the amount of money collected and how much it would have been possible to collect in the time interval considered.

The CEI provides a clear metric of the performance of debt management and collections teams: the closer the ratio is to 100%, the better the performance in managing receivables and the collections process.

The CEI can be calculated as follows:

Let's consider a concrete case with the already known monthly distribution of sales, but with the following collection hypotheses, and let's focus, for example, on the month of September.

Example #5

The table also includes a column for expired credits, as it is assumed that some collections have not been successful, and in particular those shown in red highlighted in the following figure:

It is therefore essential, to calculate this index, to divide it into:

• current credits;
• expired credits.

For each month the overall value of the credits as resulting from the accounting will therefore be equal to:

Total Credits = Current Credits + Overdue Credits

which for the month of September, the subject of our example, becomes:

With these assumptions, the CEI will return a rather low value, equal to 31.9% as indicated in the figure above.

Let us now see what the result would have been if the expired credits had been less, as shown in the following figure.

Example #6

The effect of such credit management would have been as follows:

As can be easily understood, the CEI has improved significantly, demonstrating a credit management that is certainly more efficient than in the previous case, but still needs to be improved.

Let's now imagine an ideal situation, where there are no expired credits.

Example #7

This is the ideal situation and, since the credits at the end of September are only current credits and there are no expired credits, the numerator and denominator of the CEI coincide, therefore this indicator will be equal to 100%, as shown in the following figure:

The CEI, like the DSO, also makes sense if its trend is followed over time , so as to be able to delve deeper into the dynamics of unpaid debts and investigate their possible causes.

For example, a decreasing CEI could mean an ever-increasing number of disputed invoices, capable of generating a negative impact not only on revenue, but also on customer relationship dynamics and, consequently, on sales.

Investigating more deeply, behind these numerous complaints there could be an inefficiency in the production process, or organizational, or even administrative, and this with heavy repercussions on the brand and competitiveness level first, and then on profitability and liquidity.

To conclude this overview of DSO and CEI, the two main indicators on trade credit, a short infographic with their main differences is provided below.