Definition
The term cash receipts to billed sales ratio refers to a metric that allows the investor-analyst to understand the effectiveness of accounts receivable to generate cash. Cash receipts to billed sales helps the analyst to understand the effectiveness of a company's collections processes.
Calculation
Cash to Receipts and Billed Sales = Cash Receipts / Billed Sales
Where:
Cash receipts are the amount of money received in a cash sale transaction, which includes sales on credit.Billed sales are those sales that have occurred and the consumer has been rendered a bill. Billed sales also include billed progress payments which is more common in the construction industry where customers are billed as the project progresses.
Explanation
Cash flow measures allow the investor-analyst to understand if the company is generating enough cash flow from ongoing operations to keep the company in a financially sound position over the long term. One of the ways to understand the effectiveness of a company's collection process is to calculate their cash receipts to billed sales ratio.
The investor-analyst can calculate a company's cash receipts to billed sales ratio if they wish to understand if a company's collection process is effective. This measure supplements other important metrics such as days sales outstanding (DSO) or the average collection period.
The metric takes all of the cash receipts in the test period and divides it by the billed sales for the same period. It's important that the investor-analyst aligns these two data points. In other words, the analyst should examine the billed sales and determine how much money was received from those same billed sales. If 100% of the billed amounts were collected from customers, then the metric would be equal to 1.0. If a company is writing off, or not collecting on, 50% of the billed sales then the metric would be equal to 0.5.
The cash receipts to billed sales ratio can help uncover poor collections practices such as writing off accounts receivable too quickly, which can be hidden from measures such as days sales outstanding (which does not account for write off).
Example
Company ABC's CFO is concerned about the company's collection process, which states the days sales outstanding (DSO) is less than 14 days. The CFO asked his analytical team to pull the prior quarter's total billed sales and determine how much cash was received for those same billings. The analysts found billed sales equal to $15,225,680, while cash receipts stood at $11, 114,750.
Calculating the billed sales to cash receipts ratio:
= $15,225,680 / $11, 114,750, or 0.73
Upon further investigation, the CFO found the manager - collections had been writing off accounts receivable at 45 days, thereby artificially lowering the company's DSO figure.
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