So far, we have referred to the costs of collection from paying customers in accordance with the credit terms agreed upon with them. Now, we will quantify the costs arising from the customer entering arrears.
Collection department, centres, and pre-legal – personnel and infrastructure
This is the total salaries paid to all parties involved in the “collection kingdom” directly – employees and managers. The collection centres refer to the personnel working within the centres, plus their administrative overhead.
The cost of collection
Calculating the cost of collection is quite a challenge for the collection manager. Here, we will offer some alternatives for measuring it:
Alternative #1: The collection cost per $1 collected = the total costs of the collection process divided by the total money collected.
In fact, the estimation problem stems from the difficulty of defining the two main components in the equation. In the absence of clear rules in the profession, it will be difficult to compare the organization’s results to those of other companies. Our recommendation is to decide on the components of the numerator and denominator of the equation above so that they support the organization’s policy and then perform comparisons on a monthly/quarterly/annual basis to measure the results in relation to the organization’s objectives.
Total costs related to the collection process.
First, we will discuss the simple costs to calculate, such as:
- Labor cost
- Administrative overhead
- The cost of sending the letters
- The cost of the offices and other overheads (such as electricity, telephone, property tax, computing, and maintenance)
- Legal costs: fees, deliveries, skip tracing, etc.
In addition, there are other costs involved in the collection process, such as:
- Interest accrues for debts not collected from the customer (it is easier to calculate the customer’s cost, which is loss of income, but it is also possible to calculate the alternative cost of the money not collected on time).
- The bad debts
- The cost of the indirect work factors in the organization’s investment in collection, such as the time that salespeople devote to contacting customers about collection matters or the time that customer service personnel dedicate to the collection issue.
- Improper management of the collection process may cause customers to accumulate debts passively, eventually severing ties with them.
- Loss of sales: A debtor customer is in no hurry to make upgrades or new purchases and would prefer to turn to a competitor rather than close the debt.
The total amount collected.
Determining the general amount of money collected from customers also presents us with a difficult challenge, a challenge we will encounter again when determining the incentives for the collection personnel. There are many questions that need to be decided – what is collection? When is a receipt considered a collection? What proportion of the customers would pay on their own initiative within a reasonable time even without the intervention of the collection agent? How do you differentiate between receipts from customers who pay proactively and receipts from customers resulting from the direct work of the agents? All of these questions require us to make decisions related to measuring the amount of money collected.
One alternative for calculating the general collection amount is to manually record the collection of each employee on Excel sheets or to record the value of each employee’s collection within the operational system. In both cases, a high level of supervision is required, and this does not answer the question: would the customer have paid in any case, even without the help of the agent?
Alternative calculation for the collection cost
Alternative #2 for calculating the cost of collection: it is possible to calculate the cost of collection as a percentage of the total sales turnover.
And this is for two reasons: in a large enough company, as the sales turnover increases, it is also expected that the customers’ debts in arrears will increase accordingly (this is assuming that the company manages its debts uniformly). Linking the issue of the cost of collection to the level of the amount of debts in arrears gives expression to the efficiency of collection in relation to the volume of debts to be treated.
Even though it might appear counterintuitive, a high collections-to-debt ratio can sometimes give the misleading impression of effective debt collection. This misconception arises if our primary objective—maintaining debt levels at a reasonable proportion of turnover—is met. To accurately reflect reality, it’s essential that the cost-to-collection index is kept at an appropriate level. Over time, as operational efficiencies improve and outstanding debts decrease, the ratio of collection costs to the overall financial health should also improve, indicating more efficient collection practices.
Track work in progress.
We expanded on the WIP (Work-in-process) theory – managing work in process – in the section , which deals with collection management tools. This tool becomes especially important when the organization collects through centers where many events occur that require several complex measurements.
NEXT: Risk management costs