Revenue Outstanding Measured as the Weeks Billing Outstanding

MEASURING OUTSTANDING REVENUE AS WEEKS BILLING OUTSTANDING By SACHIN GHOGLE Introduction Financial management focuses in finding the value in accounts receivable by emphasizing on improving the collections process and hence accelerating the cash flow. ‘Revenue Outstanding’ is the amount due from the customer as a result of an organisation’s normal business operation, that is, it is the amount that has been billed by organisations and is due, but which has not been collected. The management of ‘Revenue Outstanding’ is an important source of cash and hence an important parameter that the management should measure. The estimation of time to recoup the revenue outstanding is important to determine the profit of any organisation. Most prefer to receive payment immediately rather than to wait for it, especially because sometimes payment is never made in the latter scenario. There is no one general technique to estimate the time to recoup the revenue that can be adopted by all the organisations. It varies from organisation to organisation depending on the nature of business and the needs and strategies of the management. Although there is no certainty of receiving payments from all the customers, organisations use various methods to calculate the revenue outstanding or the payment that will be recovered later at a any particular point of time. The Weeks Billing Outstanding (WBO) measure calculates the revenue outstanding based on the total number of week’s billings required to recoup current Revenue Outstanding. The WBO is an important financial parameter, which shows the age in weeks, in an organization's accounts receivable and is defined in terms of the average time taken to convert the outstanding revenue into cash. The WBO measure helps the management to measure the effectiveness of collection activities and alert the management with problem accounts. If the WBO is low, then less time is spent to collect outstanding revenue. By quickly converting the billings into cash, the organisation can reinvest this cash and convert it into profits. 1 The WBO Measure A payer is responsible to pay for the services used. The total outstanding revenue of a payer is the sum of invoiced amount minus the cash received against some of the invoices minus the unallocated cash/ payments received as advance or prepayment from the payer. Some organisations report the outstanding revenue as being outstanding from the date of the invoice as opposed to the ‘due date’ of the payment. The Weeks Billing Outstanding is the total number of days billings corresponding to the payer required to recoup the current outstanding revenue for the payer divided by number of days in a week. WBO = DBO/7 This WBO is calculated for an individual payer level whereas the management needs the overall WBO for a single business unit or a particular territory. There are three methods to calculate the overall WBO for a single business unit. The overall WBO (Method 1) for a single business unit or a particular territory can then be calculated as the average of the WBO for all the payers within the corresponding business unit or territory. The overall WBO (Method 2) for a single business unit can be more accurately calculated from the business perspective by considering the weighted average of the individual WBO over an important business parameter (for example, the accumulated revenue over the past one year). These two methods can showcase the weak link or the strong link affecting the outstanding revenue. After identifying the weak link, the management can focus on the weak payers to reduce their outstanding revenue and to improve the overall cash flow within the system. The overall WBO (Method 3) can be calculated as the total number of days billings (cumulative for all the payers within the business unit) required to recoup the current total outstanding revenue for the business unit (cumulative for all the payers). Though this method cannot point the weak link, it is more accurate. 2 How to use WBO Measure Reference Date: 01 March 2008 Listed below are the aggregated Invoice figures for a Payer P1 Invoiced Amount $80,000 Cash Received $20,000 Open Amount $60,000 Unallocated Cash / Payments $15,000 Outstanding Revenue $45,000 Open Amount = Invoiced Amount – Cash Received Outstanding Revenue = Open Amount – Unallocated Cash / Payments Received US $45000 is the Outstanding Revenue from a Payer P1 Listed below is the Billing Details against Payer P1 Billing Date 1-Mar-2008 29-Feb-2008 28-Feb-2008 27-Feb-2008 26-Feb-2008 25-Feb-2008 24-Feb-2008 23-Feb-2008 22-Feb-2008 21-Feb-2008 20-Feb-2008 19-Feb-2008 18-Feb-2008 17-Feb-2008 16-Feb-2008 15-Feb-2008 14-Feb-2008 13-Feb-2008 Billing Amount $0 $0 $0 $1,000 $500 $0 $0 $0 $0 $0 $0 $0 $0 $2,000 $0 $0 $0 $2,000 Cumulative Billing Amount $0 $0 $0 $10,000 $15,000 $15,000 $15,000 $15,000 $15,000 $15,000 $15,000 $15,000 $15,000 $35,000 $35,000 $35,000 $35,000 $55,000 DAYNUM 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 This chart shows that a Billing of amount $55,000 against a Payer P1 which is greater that the outstanding revenue $45,000 from a payer P1is achieved after 18 days of billing counted from March 1, 2008. Thus the days billing outstanding that will be required to recoup the outstanding revenue is 18 days. 3 Hence the week s billing outstanding that will be required to recoup the outstanding revenue will be calculated as follows: WBO = DBO / 7 = 18 / 7 = 2. 57 Similarly, the WBO for each payer can be calculated. Consider the calculated WBO figures for n Payers to be as follows: Payer P1 P2 P3 P4 P5 P6 †¦ †¦ Pn WBO 4 2 15. 5 1. 5 1 0. 5 And the Management is interested in the Overall WBO measure for a business unit or a territory. Method 1 Overall WBO can be calculated as the average of the WBO’s of all the payers within the particular Business unit or territory. The overall WBO hence will be ? 1-N WBO ————N N = Total number of Payers The Overall WBO = (4 + 2 + 15. 5 + 1. 5 + 1 + 0. 5)/6 = 4. 09 The Overall WBO is 4. 9 even though the WBO for Payer P3 is 15. 5 4 Method 2 Now let us consider the following chart. Payer P1 P2 P3 P4 P5 P6 †¦ †¦ Pn WBO 4. 5 2 15. 5 3. 5 1 0. 5 Accumulated revenue over the past 1 year ( In Millions) 0. 5 1 50 5 2 0. 2 ? 1-n (WBO X Acc. Rev) . 25 2 775 17. 5 2 0. 1 x The considerations of a business parameter, here the Accumulated Revenue over the past one year for each of these payers will alter the view in which the WBO is to be measured from a management perspective. The management weighs payer P3 about 15 times more than payer P5 as the revenue accumulated from payer P3 is approximately 15 times more than that from payer P1. As the WBO for Payer P3 is high compared to the Overall WBO calculated in Method 1, the alternative to improve the calculation is to use a Weighted average of the WBO as opposed to the normal average. As per the new formula Overall WBO = ? 1-n (WBO X Acc. Rev) ——————————-? 1-n (Acc. Rev) Overall WBO = ( 2. 25 + 2 + 775 + 17. 5 + 2 + 0. 1) ——————————————-(0. 5 + 1 + 50 + 5 + 5 + 2 + 0. 2 ) = 798. 85 / 58. 7 = 13. 61 The new Overall WBO is now closer to the WBO of the Payer P3 who is a major payer for the organization. 5 Method 3 Listed below are the aggregated Invoice figures for a single business unit Invoiced Amount $1. 50 Cash Received $0. 80 Open Amount $0. 70 Unallocated Cash / Payments $0. 20 Outstanding Revenue $0. 50 $0. 5 million is the overall outstanding revenue for the business unit Listed below is the overall Billing Details for the business unit Billing Date -Mar-2008 29-Feb-2008 28-Feb-2008 27-Feb-2008 26-Feb-2008 25-Feb-2008 24-Feb-2008 23-Feb-2008 22-Feb-2008 21-Feb-2008 20-Feb-2008 19-Feb-2008 18-Feb-2008 17-Feb-2008 16-Feb-2008 15-Feb-2008 14-Feb-2008 13-Feb-2008 12-Feb-2008 11-Feb-2008 Billing Amount $0. 00 $0. 00 $0. 00 $0. 05 $0. 10 $0. 00 $0. 00 $0. 00 $0. 07 $0. 00 $0. 05 $0. 00 $0. 00 $0. 05 $0. 00 $0. 80 $0. 00 $0. 02 $0. 00 $0. 10 Cumulative Billing Amount $0. 00 $0. 00 $0. 00 $0. 05 $0. 15 $0. 15 $0. 15 $0. 15 $0. 22 $0. 22 $0. 27 $0. 27 $0. 27 $0. 32 $0. 32 $0. 40 $0. 40 $0. 42 $0. 42 $0. 52 DAYNUM 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 These charts show that a Billing of amount $0. 2 million which is greater that the outstanding revenue $0. 5 million is achieved after 20 days of billing counted from March 1, 2008. Thus the days billing outstanding that will be required to recoup the outstanding revenue is 20 days. Hence the weeks billing outstanding that will be required to recoup the outstanding revenue will be calculated as follows WBO = DBO / 7 = 20 / 7 = 2. 86 6 Based on the pros and cons of the various methods, every organization would select a method to measure its Weeks Billing Outstanding, which wil l form the baseline for their reporting. Then the management has to devise appropriate procedures to gather the required data to implement the selected method. 7