KPIs for credit risk and receivables management

Many forecasts in the news have to be corrected shortly afterwards and public policy to contain the spread of the virus still follows outbreaks of infection. For many companies affected this means that long-term planning is impossible. For credit managers this means that events need to be followed closely, as has been the case since the beginning of the pandemic. It is important to have a very close look at the individual situation of one's own business partners: in which sector does the company operate? What is their financial position and how will their liquidity be impacted? Credit and receivables management, which are part of accounts receivable management, provide essential KPIs for this purpose.

On the one hand, these KPIs serve as early warning indicators and provide conclusions on any impending risks. The company is then able to take preventive or mitigating measures in good time – or decide to consciously take risks. On the other hand, starting points for optimising internal processes can be derived from the findings. Ultimately, the findings are also relevant for sales and should therefore be made available to that department: they help in deciding which customers to attend to.

When selecting KPIs (key performance indicators) it is important to consider their strategic relevance: they should focus primarily on the targets set by the company or a department. This is the only way to ensure that the knowledge gained is used in line with the corporate strategy and serves as a basis for future corporate management.

The question credit managers should ask themselves when selecting KPIs is: "What do I do with that knowledge?" If this question cannot be answered, this KPI is obviously not very relevant – at least at this point in time.

KPIs should:

• make the degree of target achievement measurable
• form the basis for deriving specific measures when the targets are not achieved

Often, less is more. It is more sensible to analyse only a few KPIs, but the right ones and at regular intervals, rather than examining as many unspecific KPIs as possible that are not followed up by any action. As already mentioned above: the aim is drawing the right conclusions from the KPIs to achieve the corporate goals.

Moreover, data analysis and interpretation can take an enormous amount of time if it is not targeted and supported by technology. Efficient and simple data analysis requires data in digital format that can be processed automatically – also visually. 

The most important receivables and credit management KPIs are described in the following sections. There may well be differences with regard to the relevant KPI in each individual case. As mentioned above, each company pursues different goals so that different KPIs may be important, such as the success rate of recovery measures or the payment history of existing customers, which are not explained in further detail below. 

2.1 Receivables turnover

How often is the average accounts receivable balance included in sales revenue? This KPI should be as high as possible.

If it goes down over time, this means that the days sales outstanding (or DSO, see following point) goes up. This increases the tied-up capital, which in turn puts a strain on your liquidity.

Any decrease in this KPI should be seen as a warning: credit management measures should be taken to reduce the DSO, for example.

2.2 DSO (days sales outstanding)

Days sales outstanding (DSO) can be used as an alternative to receivables turnover. It is one of the most common KPIs used for credit management.

It describes the average number of days between invoicing and receipt of payment and should be as low as possible: a short average days sales outstanding period means higher capital turnover, which in turn improves the return on investment (ROI).

The days sales outstanding are kept low by

• a good customer structure (i.e. a large share of customers with good credit ratings)
• the right payment terms
• rigorous receivables management, characterised by swift invoicing and a professional dunning process

2.3 Working capital

Working capital is a balance sheet ratio and is calculated by deducting current liabilities from current assets. It serves to assess a company's financial position, i.e. provides information on uncommitted, readily available liquid funds and therefore its solvency. This KPI plays a role in financial statement analysis, and usually also in credit and risk assessments.

If working capital is greater than zero this means that the entire non-current assets as well as part of current assets are funded through non-current equity – and that uncommitted capital is available to cover current liabilities. Negative working capital on the other hand means that current assets are insufficient to cover current liabilities: there is a risk that the company becomes illiquid.

However too much working capital, at least from a financial point of view, is also not desirable: it means that liquid funds remain unused, for example, or that inventories are too high or similar.

Determining the "right" amount of working capital for a company requires taking into account corporate and industry-specific requirements as well as economic factors.

2.4 Bad debts and bad debt ratio

How high are the bad debts and their share of revenue? Logically, this ratio should be as low as possible.

How many receivables are in default during a certain period? Bad debts affect your liquidity 1:1 and reduce your profits – and not only that, usually you have also incurred dunning costs on top. In addition, these KPIs reflect the quality of the measures taken in credit management: How good is the data basis? Are the credit assessment results accurate and are ratings carried out sensibly and correctly? Are the risk assessments realistic or have criteria relevant to risk been left out?

2.5 Cost structure

• Costs for assurance:
  You should keep an eye on the costs incurred for credit insurance, for example – in total and at customer level.
• Costs for verification fees:
  Expenses for credit reports or credit insurance verification fees impact your liquidity directly.
• Value at risk:
  Value at risk is a KPI used for measuring and monitoring market and interest rate risks. It has its origins in the banking and insurance sector but is lately increasingly also used in corporations. It reflects the exposure of assets to risk – taking into account probabilities over a certain planning horizon. It is useful for portfolio management.

The digitalisation of credit management using software makes it possible to compile KPIs regularly and at the touch of a button. It is important that the necessary data are available in the system. If that is the case, almost any question can be easily answered:

• How are your customers allocated to ratings categories?
• What is your current DSO and does it change over time?
• Which customers have the highest limits, commitments, outstanding items and/or order volumes?
• Which of your customers have exceeded their limits the most?
• How are outstanding items/bad debts spread across your branch offices?
• How many and which customers have credit insurance lines in place and in what amount?
• Which balances do you need to report to the credit insurer?

Another way to make things easier is to visualise analysis results: a lot of information is much easier to comprehend in graphic form. Graphics make presentations understandable and thus represent a useful supplement for discussions – also with the sales department – and for deriving strategic measures. By using credit management software, for example, all the necessary information can be analysed in a targeted and comprehensive manner. In this way, you can control and manage your customer portfolio, support sales and continuously improve your own processes. 

Source: KPMG Corporate Treasury News, Edition 113,  July/August 2021
A guest article by:
Dr Stefan Gröger
HEAD OF BUSINESS DEVELOPMENT INDUSTRY & TRADE
Prof. Schumann GmbH | Weender Landstr. 23 | 37073 Göttingen 
Email: info@prof-schumann.de