At the end of each year, when you evaluate your collection agency performance, what method do you use to calculate their recovery rate and over what period of time do you analyze? We discuss this topic very frequently with our clients. Contingency based collection agencies only earn revenue if they collect the debt that is placed with them, therefore, the recovery rate is usually the critical factor for allowing both the client and the agency to properly evaluate their relationship. If a collection agency has a 50% recovery rate for your company, an excellent result, it still means that 50% of the time they are working for free as they still must work the files they are not able to collect on. Fixed expenses such as rent, payroll, insurance, electric, phones all must still be met. Given this, and the fact that over the past 20 years the average fee charged by an agency has been dramatically reduced, collection agencies are laser focused on collecting as much money as they can, in-house, in the shortest period of time. This is how they make the most money for both their clients and themselves.
As many companies use more than one collection partner, most measure head to head performance by how much money an agency brings back to the bottom line. Ultimately, the agency that nets you the most cash will probably get the most placement volume. However, is the method of evaluation you are using really showing you who is doing the best job for your company in the long run and collecting on the most files? You should realize that how collection agencies judge themselves is often very different from how they are judged by their clients.
To compare the various performance measures, let’s assume that you are turning over, to your collection agency, 30 past due accounts per month with an average accounts receivable balance of $5,000 per file. The accounts are from 120 days to 240 days past due, and two accounts per month or $10,000 are defunct corporations or uncollectible at placement that cannot be recovered. Now let’s look at three different ways that collection agency recovery performance can be evaluated on the last day of the year, six month later, twelve months later and twenty-four months later.
Gross Collections Method (GCM)
GCM = Amount Collected / Total Dollars Placed
In Year 1, the total dollars placed was $1,800,000 and the amount collected on Year 1 placements at the end of Year 1 was $700,000. Therefore, at the end of Year 1, the GCM for Year 1 placements was 700,000/1,800,000 or 38.9%.
Six months after the end of Year 1 an additional $250,000 has been collected on Year 1 placements so at that time the GCM for Year 1 placements is 950,000/1,800,000 or 52.8%
Twelve months after the end of Year 1 an additional $50,000 has been collected on Year 1 placements so at that time the GCM for Year 1 placements is 1,000,000/1,800,000 or 55.6%
Twenty-four months after the end of Year 1 an additional $25,000 has been collected on Year 1 placements so at that time the GCM for Year 1 placements is 1,025,000/1,800,000 or 56.9%
Net Collections Method (NCM)
NCM = Amount Collected / (Total Dollars Placed – Uncollectable at Placement)
In Year 1, the total dollars placed was $1,800,000 and the amount uncollectible at placement was $120,000. Therefore, the net amount available for collection was $1,680,000. The amount collected on net Year 1 placements at the end of Year 1 was $700,000. Therefore, at the end of Year 1, the NCM for Year 1 placements is 700,000/(1,800,000-120,000) or 41.7%.
Six months after the end of Year 1 an additional $250,000 has been collected on net Year 1 placements so at that time the NCM for Year 1 placements is 950,000/1,680,000 or 56.5%
Twelve months after the end of Year 1 an additional $50,000 has been collected on net Year 1 placements so at that time the NCM for Year 1 placements is 1,000,000/1,680,000 or 59.5%
Twenty-four months after the end of Year 1 an additional $25,000 has been collected on net Year 1 placements so at that time the NCM for Year 1 placements is 1,025,000/1,680,000 or 61.0%
Net Cost of Collection Method
NCCM = (Amount Collected – Commissions Paid) / Total Dollars Placed
In Year 1, the total dollars placed was $1,800,000, the amount collected on Year 1 placements at the end of Year 1 was $700,000, and the commissions earned were $140,000. Therefore, at the end of Year 1, the NCCM for Year 1 placements is (700,000-140,000)/1,800,000 or 31.1%.
Six months after the end of Year 1 an additional $250,000 has been collected on Year 1 placements with additional commissions earned of $50,000. Therefore, at that time the NCCM for Year 1 placements is 760,000/1,800,000 or 42.2%
Twelve months after the end of Year 1 an additional $50,000 has been collected on Year 1 placements with additional commissions earned of $10,000. At that time, therefore, the NCCM for Year 1 placements is 800,000/1,800,000 or 44.4%
Twenty-four months after the end of Year 1 an additional $25,000 has been collected on Year 1 placements with additional commissions earned of $5,000. At that time, the NCCM for Year 1 placements is 820,000/1,800,000 or 45.6%
CONCLUSION
All of the methods described above provide a reasonable approach for evaluating collection agency performance as long as they are applied consistently. Consideration must also be given to open inventory at the time of evaluation. A percentage of the open accounts will still turn into dollars at some point. Given the historical 90-120-day lag on in-house collections as well as the overall backlog of the legal system that is often used in collection agency recovery efforts demonstrate that only evaluating collections in a single placement year at the end of that year, can produce a measure that does not truly represent agency performance. Our choice for the one which that most reflects true agency performance is the Net Collection Method, but no matter which method you choose, we feel recovery results for a specific period of time, such as annually, should be evaluated six, twelve, eighteen and 24 months after the end of that period. This will provide the best measure of agency performance short-term and over-all long-term. Given with most collection portfolios the majority of collections for placements made in the last quarter of a year will most likely occur in the first six months of the following year, if you only review results at the end of the year, this performance will be excluded from your analysis.
Additionally, evaluating an agency based on accounts that when placed are out of business or defunct corporations and are impossible to collect from is inherently unfair and will produce a biased comparative measure if different agencies are given placements with different percentages of uncollectible dollars.
Once again, you can look at this topic many ways and our goal in this blog post has been to shed some light on the difference approaches and how it may affect your agency review.