How Much Should You Spend on AR Customer Communications?
6 min.
Ah, the elusive sweet spot of Customer Communications spending—a puzzle that keeps SME owners in accounts receivable management on their toes. Spend too little, and you're out of touch, leaving debts uncollected. But overshoot the budget, and you're essentially chasing debts with money you can't afford to lose. So, what's the magic number?
We call it the Optimal Communication Cost, or “OCC” for short. Believe us, it’s not going to be pretty. But at the end of this article, you’ll be able to calculate precisely how much you should spend on communications to keep your collections on point.
How to Calculate Optimal Communication Cost (OCC)
If you are not the numbers person in your company, you might want to call them in for this one. It’ll be worth it.
The equation looks something like this:
We know there are too many letters to be a math problem, but before you click away, let’s break down every variable so you can see what we mean by this.
Variables Explained:
Total Recoverable Debt (TRD): The total amount of money that is realistically recoverable from all customers. For starters, you should account for that, on average, companies write off 1.5% of their receivables as bad debt.
Total Number of Customers (TNC): The total number of customers you need to communicate with.
Success Rate of Communication (SRC): The percentage of successful communications that lead to debt recovery. This should be in decimal form (e.g., 0.6 for 60%).
Cost of Non-Communication (CNC): The cost incurred due to lack of communication, such as additional late fees, legal charges, or lost business. This should also be in decimal form.
Efficiency Factor (EF): A multiplier that accounts for the efficiency of your communication channels. This could range from 0 to 1, where 1 is highly efficient and 0 is not efficient at all.
Calculating OCC, Step-by-Step
Step 1: Gather Your Data
First, you'll need to gather some essential data:
Total Recoverable Debt (TRD).
Total Number of Customers (TNC).
Success Rate of Communication (SRC).
Cost of Non-Communication (CNC).
Efficiency Factor (EF).
The first two should be easy, but we’ll need to do some calculations for the other three.
Calculating Success Rate of Communication (SRC)
Variables Explained:
Number of Successful Communications (NSC): The number of communications that successfully led to a customer taking the desired action (e.g., making a payment, setting up a payment plan, etc.).
Total Communications Sent (TCS): The total number of communications sent out to customers. This includes emails, letters, phone calls, etc.
How to Use the Equation:
Count the Number of Successful Communications: Track how many communications led to a successful debt collection or other desired actions.
Count the Total Communications Sent: This should include all types of communications—emails, letters, phone calls, etc.
Divide: Divide the Number of Successful Communications (NSC) by the Total Communications Sent (TCS).
For example, if you sent out 100 emails and 60 led to successful debt collections, your SRC would be 60/100 = 0.6 (or 60%).
Calculating Cost of Non-Communication (CNC)
Variables Explained:
Lost Revenue (LR): The amount of money that could have been recovered but was not due to lack of communication. This could include debts that have become uncollectible.
Additional Costs (AC): Any extra costs incurred due to lack of communication. This could include legal fees, late fees, or even the cost of additional resources needed to manage escalating debts.
Total Recoverable Debt (TRD): The total amount of money that is realistically recoverable from all customers.
How to Use the Equation:
Calculate Lost Revenue: Estimate the amount of money not recovered due to lack of communication.
Calculate Additional Costs: Sum up any extra costs, like legal or late fees.
Divide by Total Recoverable Debt: This puts both Lost Revenue and Additional Costs in the context of the total amount that could potentially be recovered.
Sum Up: Add both components to get the total Cost of Non-Communication (CNC).
The CNC will be in decimal form, which you can then plug into the original equation for Optimal Communication Cost (OCC).
For example, if your Lost Revenue is $10,000, Additional Costs are $5,000, and Total Recoverable Debt is $100,000, then:
CNC = (10,000/100,000) + (5,000/100,000)
The result is 0,15, which means that the cost of not communicating effectively with your customers is 15% of the total recoverable debt.
Calculating Efficiency Factor (EF)
Variables Explained:
Success Rate of Communication (SRC): The percentage of successful communications that lead to debt recovery. You should have it already.
Amount Recovered Through Communications (ARC): The total debt recovered through these communications.
Total Recoverable Debt (TRD): The total amount of money that is realistically recoverable from all customers.
How to Use the Equation:
Calculate the Recovery Efficiency: Divide the Amount Recovered Through Communications (ARC) by the Total Recoverable Debt (TRD).
Multiply Both Factors: Multiply SRC with Recovery Efficiency.
The EF will be between 0 and 1, where 1 indicates maximum efficiency and 0 indicates no efficiency.
If you’ve got an SRC of 0.6, an ARC of $40,000, and a TRD of $100,000, the equation you need to do is:
EF = 0.6 x (40,000/100,000)
Giving you an Efficiency Factor of 0.24.
Step 2: Calculate the Average Debt Per Customer
Now that we have an SRC, a CNC, and an EF, we can continue with the equation.
To calculate the ADC, you must divide the Total Recoverable Debt (TRD) by the Total Number of Customers (TNC). This gives you an average debt per customer.
Let’s set TNC at 500.
ADC = 100,000 / 500
This gives you an Average Debt per Customer of $200.
Step 3: Calculate the Net Success Rate
Subtract the Cost of Non-Communication (CNC) from the Success Rate of Communication (SRC). This gives you the net success rate.
Following the example:
NSR = 0.6 - 0.15
NSR = 0.45
Step 4: Calculate Optimal Communication Cost (OCC)
Now, we have every piece of the puzzle to calculate the OCC, but let’s simplify the OCC equation based on the previous calculations.
OCC = ADC x NSR x EF
Before the big reveal, let’s list the variables we’ve calculated:
Average Debt Per Customer (ADC): 200
Net Success Rate (NSR): 0.45
Efficiency Factor (EF): 0.24
OCC = 200 x 0.45 x 0.24
OCC = $21.6
Conclusion
And there you have it! That’s the exact amount you should aim to spend when communicating with each customer.
Now, if you want to figure out how much you are spending per customer, that’s an equation that’ll have to wait for our next article. If you want to figure it out yourself, some numbers you should consider are:
