Average collection period is a company’s average time to convert its trade receivables into cash. It can be calculated by dividing 365 (days) by the accounts receivable turnover ratio or average accounts receivable per day divided by average credit sales per day. The average collection period is calculated by dividing the net credit sales by the average accounts receivable, which gives the Accounts receivable turnover ratio. To determine the average collection period, divide 365 days by the accounts receivable turnover ratio.

Generally speaking, companies want to minimize their average collection period. Overall shorter collection periods increase liquidity and generate better cash flow efficiency. Companies use the average collection period as a key aspect of operating cash flow management, determining the optimal collection period for their company’s needs. Oftentimes, companies will also consider accounts receivable write-offs in conjunction with average collection period days for a broader assessment. Creditors may also follow average collection period data and may even include threshold requirements for maintaining credit terms.

1. Let’s say that Company ABC recorded a yearly accounts receivable balance of $25,000.
2. The average collection period is used a few different ways to measure cash flow performance.
3. 🔎 You can also enter your terms of credit in our calculator to compare them with your average collection period.
4. One of the simplest ways to calculate the average collection period is to start with receivables turnover which is calculated by dividing sales over accounts receivable to determine the turnover ratio.
5. At the beginning of the year, your accounts receivable were at $5,000, which increased to $10,000 by year-end.

Why Is the Average Collection Period Important?

This metric should exclude cash sales (as those are not made on credit and therefore do not have a collection period). 15 to 30 days should be the average collection period for accounts receivable. Discounts are always an enticing opportunity to increase sales and encourage customers to pay.

Is a shorter average collection period always better?

The time they require to collect the money back from the customer is known as the accounts receivable collection period. When customers take their steps to make payments, waiting for processing time to end is not good for both. Before starting this, the accounts receivable team should estimate the total collection made for the year and the total net sale amount (the amount they might have made with sales throughout the year). Receiving early payments is essential to plan your financial forecasts the right way and adhere to budgets accurately. For obvious reasons, the lower the ACP is, the better it is for your business. It means that your clients take a shorter period of time to pay their bills and you have less uncertainty about payment times.

The earlier the supplier gets the funds, the better it is for business because this fund is a huge source of liquidity. In addition, it can be readily used to make short-term payments or obligations. It can set stricter credit terms limiting the number of days an invoice is allowed to be outstanding. This may also include limiting the number of clients it offers credit to in an effort to increase cash sales. It can also offer pricing discounts for earlier payment (i.e. 2% discount if paid in 10 days).

How is the Average Collection Period Formula Derived?

As we’ve said before, the average collection period offers limited insights when analyzed in isolation. Instead, review your average collection period frequently and over a longer duration, such as a year. This way, you’ll understand what the number means and the “why” behind it. By monitoring and improving the ACP, companies can enhance their liquidity, reduce the risk of bad book value is also referred to as debts, and maintain a healthy financial position. The result above shows that your average collection period is approximately 91 days. In the following example of the average collection period calculation, we’ll use two different methods.

Why Is It Critical to Track the Average Collection Period?

You need to calculate the average accounts xero export receivable and find out the accounts receivables turnover ratio. The average collection period is the timea company’s receivables can be converted to cash. It refers to how quickly the customers who bought goods on credit can pay back the supplier.

It is calculated by dividing net credit sales by average accounts receivable. Most modern businesses use accrual accounting, offering their customers the option to buy now and pay later. This process is typically done through invoicing which requires a company to set collection period parameters and deploy specific receivables procedures. While a “buy now, pay later” model theoretically seeks to increase sales, the downside is it delays and creates some uncertainty for cash flow payments. As such, it can become more difficult to finance day-to-day operations or make future investments. Average collection period is calculated by dividing a company’s average accounts receivable balance by its net credit sales for a specific period, then multiplying the quotient by 365 days.