Chances are, like every other organization on the block, your Finance department is tracking DSO and if the DSO metric is close to the corporate goal of, say, 30 days, declaring everything to be wonderful and right with the customer base. But is this really the case?

As a recent article over on CFO.com that points out the trouble with DSO, an acceptable DSO might not be acceptable at all. First of all, DSO can be manipulated. Secondly, increases in DSO can indicate a situation where a company is “forcing” sales by accepting poor receivable terms, or selling its product at a discount to create sales. (Not good at all!) Thirdly, not only will most customers not pay a net 30 day invoice early, some customers will pay on day 30 like clockwork and should probably be excluded from the DSO calculation.

According to the authors of the aforementioned article, what is really important is collections relative to accounts that have come due, not the current receivables unlikely to be paid early. In order to capture this, the authors are recommending a different metric, the Collection Effectiveness Index (CEI). In this index, 100 is a perfect score, but 100 can be exceeded if a company asks for, and gets, cash in advance. The calculation of CEI is as follows:

It’s an interesting calculation, and I see one advantage for Procurement. During the calculation, the analyst will have to identify those customers with amounts due in “current”. If a customer shows up in this bucket month after month, they probably aren’t a good customer to have. And if a customer never shows up in this bucket, they are probably a good customer to have. This will help Procurement prioritize customer requests as the requests from good customers should get priority, as that is what can keep an organization afloat in trouble times.

Any different thoughts?