80/20 Rule for Receivables Management

Perhaps you’ve heard of the Pareto Principle that is better known as the 80/20 rule. Simply stated, it says that for many events roughly 80% of the effects come from 20% of the causes.

Some Examples

A school may find that 20% of their students create 80% of their problems, while another 20% achieve 80% of their positive results. It’s true in other organizations. In churches, 80% of the volunteer work often is done by 20% of the membership. Though the actual percentages may vary slightly, it still is fundamentally accurate much of the time, sad as that may be. If you own a business, look carefully to see who is accomplishing the work. Again, you may find that20% of your employees contribute about 80% of the results. The flipside of this is that 20% of your employees may well be creating 80% of your problems. The Pareto Principle is frequently amazingly accurate.

Some More Examples

If you inventory is too high, do a little analysis. You may well find that the Pareto Principle holds true in that only 20% of your items represent 80% of the overstock. Again, the actual percentage may vary. It may be that 10% or 30% represent 80% of the overstock, but still the fundamental concept holds true much of the time. The 80/20 rule is amazingly accurate.

Pareto Principle and Receivables

Like inventory, a close examination of receivables using the Pareto Principle may show you that around 20% of your customers are causing 80% of your collection problems. These are the customers that frequently are also creating problems in other ways, such as excessive returns, reporting shortages on shipments, or complaining that something is broken or not what they thought they were ordering.

Applying this to Receivables

Suppose that your receivables show accounts over 90 days. You can sort the receivables in descending order according to the over 90 days balance. Then, calculate the cumulative amount going down the list. In accordance with the Pareto Principle or 80/20 rule, once you reach approximately 80% of the over 90 day amount, stop. I think there is a great possibility that you will have approximately 20% of your total number of over 90 day customers. You now have a starting point for which customers to contact first.

Again, your actual experience may be somewhat different, but the use of the Pareto Principle is a quick way to zero in on problem areas. So, give it a try. I think you may find this technique surprisingly useful.

If you want to know more, contact AimCFO – Contact

As always, your comments are welcomed.

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