What is Average Collection Period? Formula & Interpretation

how to calculate the average collection period

The quick ratio is a calculation that measures a company’s ability to meet its short-term obligations with its most liquid assets. Accounts receivable are the balance of money due to a firm for goods or services delivered or used but not yet paid for by customers. Companies prefer a lower average collection period over a higher one as it indicates that a business can efficiently collect its receivables. For example, the banking sector relies heavily on receivables because of the loans and mortgages that it offers to consumers. As it relies on income generated from these products, banks must have a short turnaround time for receivables. If they have lax collection procedures and policies in place, then income would drop, causing financial harm. Clearly, it is crucial for a company to receive payment for goods or services rendered in a timely manner.

how to calculate the average collection period

It’s not enough to look at a final balance sheet and guess which areas need improvement. You must monitor and evaluate important A/R key performance metrics in order to improve performance and efficiency. Both equations will produce the same average collection period figure if you have the appropriate data. The average period to collect a receivable can vary widely between different companies and industries.

Average Collection Period Formula

For example, analyzing a peak month to a slow month by result in a very inconsistent average accounts receivable balance that may skew the calculated amount. For the company, its average collection period figure can mean a few things. It may mean that the company isn’t as efficient as it needs to be when staying on top of collecting accounts receivable. However, the figure can also represent that the company offers more flexible payment terms when it comes to outstanding payments.

If the firm above, with an average collection period of 22.8 days, has 30-day terms, they’re in great shape. If they have 14-day terms, that means few customers are actually paying on time. Whether your average collection period is “good” or “bad” will depend on how close it is to your credit terms—though lower is generally better. If your company requires invoices to be paid within 30 days, then a lower average than 30 would mean that you collect accounts efficiently. An average higher than 30 can mean that you’re having trouble collecting your accounts, and it could also indicate trouble with cash flow. Similarly, it can help in assessing the credit policy of the company as the average days from the credit sale to credit collection can help you know how your business is fairing.

How to Automate Your Accounts Receivable Process for Accelerated Cash Flow

This is important because without cash collections, a company will go insolvent and lack the liquidity to pay its short-term bills. This is important because a credit sale is not fully completed until the company has been paid. Until cash has been collected, a company is yet to reap the full benefit of the transaction. Calculating the average collection period for any company is important because it helps the company better understand how efficiently it’s collecting the money it needs to cover its expenditures.

  • Most businesses require invoices to be paid in about 30 days, so Company A’s average of 38 days means accounts are often overdue.
  • When analyzing average collection period, be mindful of the seasonality of the accounts receivable balances.
  • Your average collection period is the number of days between when a sale was made or a service was delivered and when you received payment for those goods or services.
  • The average receivables period is computed by dividing Net Credit Sales by 365 days, and then dividing the result into Average Accounts Receivables.
  • Now Company A has all of the information it needs to calculate the ratio.
  • The first formula is mostly used for the calculation by investors and other professionals.

A few other KPIs that a company needs to compare it with, to get a clear picture of what the ACP indicates. These include the industry standard of the average collections period and the company’s past performance.

Example of Calculating Your Average Collection Period

Before joining Versapay, Nicole held various marketing roles in SaaS, financial services, and higher ed. That said, there’s always room for improvement, and bringing the number down even further will certainly improve your cash flow and benefit your business. While the collection period formula is useful for measuring how efficiently you collect receivables, it has its limitations.

how to calculate the average collection period

This number is the total number of credit sales for the period, less payments you received. The importance of metrics for your accounts receivable and collections management isn’t average collection period formula lost on you. You need a measuring stick to determine exactly how effective your efforts are. In this example, first, we need to calculate the average accounts receivable.

This way, companies can use this formula to determine how many days they have until they need to start charging interest on unpaid debts. Because the amount of time a company has to collect on debt changes yearly, the average collection period is a crucial calculation to help you determine how long debt collection typically takes. The monitoring of the average collection period is one way to track a company’s ability to collect its accounts receivable. To improve the average collection period, companies must become proactive in their collections approach. Automating the order to cash process to make it more efficient will also help reduce DSO.

To do this, you take the sum of your starting and ending receivables for the year and divide it by two. The average collection period for accounts receivable does more good if done frequently and properly. Frequently conducting an average collection period analysis is important to ideate your collections strategy and improve liquidity.

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