What Is the Average Collection Period and How Is It Calculated?

In this article, we will cover in detail about the account receivable collection period. This include the key definition, purpose, formula, explanation and analysis as well as its limitation. Before we jump into detail, let’s understand the overview as well as some key definition below. This metric should exclude cash sales (as those are not made on credit and therefore do not have a collection period). A good average collection period (ACP) is generally considered to be around 30 to 45 days. However, this can vary depending on the industry, company size, and payment terms.

It means that Company ABC’s average collection period for the year is about 46 days. It is slightly high when you consider that most companies try to collect payments within 30 days. As we are aware of, most businesses rely on profits to show how they have performed.

Limitation of Account Receivable Collection Period

For stakeholders like investors and creditors, this metric reflects financial stability and operational efficiency. A company that collects receivables faster than its peers demonstrates effective credit control, enhancing its appeal to investors. The average collection period evaluates a company’s credit management and customer payment habits. A longer period may signal difficulties in maintaining liquidity, potentially affecting the ability to meet obligations or invest in growth.

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By assessing this period, companies can refine their credit policies and better understand customer payment behaviors. Account receivable collection period is also an indicator of the performance of the credit control department of a business. It is the duty of the credit control department of a business to ensure the collection period of the balances is lesser or at least the same as the agreed credit period. It can also be used to make decisions about factoring account receivables or outsourcing the credit control department. This can also easily be calculated in number of weeks or months if the credit periods are longer.

What is the average collection period in accounts receivable?

The Trade Receivables Collection Period is a vital financial metric that measures the average number of days a company takes to collect payments from its credit customers. This period is crucial for maintaining healthy cash flow and ensuring the business operations run smoothly. In this example, the graphic design business has an average receivables’ collection period of approximately 10 days. This means it takes around 10 days, on average, for the business to collect payments from their clients for credit sales. The average collection period is closely related to the accounts turnover ratio, which is calculated by dividing total net sales by the average AR balance. The average collection period is an accounting metric used to represent the average number of days between a credit sale date and the date when the purchaser remits payment.

At its simplest, your company’s average collection period (also called average days receivable) is a number that tells you how long it generally takes your clients to pay you. trade receivables collection period formula Days sales outstanding is most useful when compared to the standard number of days that customers are allowed before payment is due. Thus, a DSO figure of 40 days might initially appear excellent, until you realize that the standard payment terms are only five days. DSO can also be compared to the industry standard, or to the average DSO for the top performers in the industry, to judge collection performance. The average collection period is often analyzed alongside other receivables metrics for a comprehensive view of credit and collections efficiency. Consider GreenTech Solutions, a fictional company specializing in eco-friendly technology products.

Long collection days of credit sales will lead to insufficient cash to pay for these things. The collection period of credit sales is one of the most important key performance indicators that are closely and strictly monitored by the board of directors, CEO, and especially CFO. A lower average collection period is generally better, says Blackwood—because a lower figure indicates a shorter payment time. A fast collection period may not always be beneficial as it simply could mean that the company has strict payment rules in place. However, stricter collection requirements can end up turning some customers away, sending them to look for companies with the same goods or services and more lenient payment rules or better payment options.

Company size

• There’s no one-size-fits-all answer for what makes a “good” Average Collection Period.
• However, the cash flows of a business can also give a lot of useful information about a business.
• Either way, any cash generated from sales to customers, by the business, plays a vital role in the long-term stability and success of a business.
• Upon dividing the receivables turnover ratio by 365, we arrive at the same implied collection periods for both 2020 and 2021 — confirming our prior calculations were correct.
• A shorter ACP generally indicates better cash flow management and a healthier financial position.

Using those assumptions, we can now calculate the average collection period by dividing A/R by the net credit sales in the corresponding period and multiplying by 365 days. Businesses often sell their products or services on credit, expecting to receive payment at a later date. Your average collection period tells you the number of accounts receivable days it takes after a credit sale to receive payment. Analysing the receivables collection period over time allows companies to identify trends and patterns. A consistent increase in the collection period may indicate a need to revise credit policies. In contrast, a decreasing collection period could signify improvements in credit management.

The company wants to assess the account receivable outstanding at the end of December 2016. Discover ways to manage cash flow for your business with BDC’s free guide, Taking Control of Your Cash Flow. Longer collection times may be most challenging or risky for manufacturing companies, which often face higher costs at the start of the cash conversion cycle, says Blackwood. Clearly, it is crucial for a company to receive payment for goods or services rendered in a timely manner. It enables the company to maintain a level of liquidity, which allows it to pay for immediate expenses and to get a general idea of when it may be capable of making larger purchases.

More specifically, the company’s credit sales should be used, but such specific information is not usually readily available. Companies should also consider leveraging cash collection technology to streamline their collection processes. Implementing an efficient and automated invoicing system can enhance accuracy and timeliness while reducing manual errors.

The company’s top management requests the accountant to find out the company’s collection period in the current scenario. We will take a practical example to illustrate the average collection period for receivables. Although cash on hand is important to every business, some rely more on their cash flow than others. In addition to being limited to only credit sales, net credit sales exclude residual transactions that impact and often reduce sales amounts. This includes any discounts awarded to customers, product recalls or returns, or items reissued under warranty. This is because the company could not even get the cash from sales of its goods or services but lost them as expenses.

This article will explore the ACP formula, its significance, and how to use an ACP calculator to gain insights into your company’s cash flow management. Understanding the average collection period is crucial for businesses as it measures how efficiently they manage their accounts receivable. This metric indicates the average number of days it takes a company to collect payments from customers, directly impacting cash flow and financial planning. From the account receivable collection period of XYZ Co., it can be determined that the business has done exceptionally well when it comes to managing its account receivable balances. Not only have XYZ Co. managed to recover its balances within the 30 days credit period limit but also managed to do it 9 days (30 days – 21 days) before. Since the result is better than expected, XYZ Co. can also consider loosening its credit control policies to attract more sales.

When determining the average collection period, how is accounts receivable turnover calculated?

If a customer does not pay within the promised time, the business can actively pursue to customer or else end up risking the recoverability of the balance. Another tool used to control account receivable balances is the account receivable collection period. Average collection period is calculated by dividing a company’s average accounts receivable (AR) balance by its net credit sales for a specific period, then multiplying the quotient by 365 days.

• If businesses only generate profits but fail to generate cash flows, they can face a lot of problems.
• First, long outstanding accounts receivable could potentially lead to bad debt and the effect is more adverse than the risk of late collection.
• The Trade Receivables Collection Period is a critical aspect of financial management, directly influencing a company’s cash flow and operational stability.

There’s no one-size-fits-all answer for what makes a “good” Average Collection Period. Ideally, a shorter collection period is generally preferred, as it indicates that the company collects receivables quickly and has efficient credit and collections practices. This typically suggests a well-managed cash flow and a more financially stable operation, as funds are being reinvested into the business sooner. The accounts receivable collection period compares the outstanding receivables of a business to its total sales.