The short period of days signified good collection or credit assessment performance, while the long period of days referred to a long outstanding debt. When a company creates a credit policy, it sets the terms of extending credit to its customers. Credit policies normally specify when customers need to pay their bills, what the interest charges and fees are if payments are late, and whether there are any benefits for paying early. Credit policies don’t address how often their customers will pay per year, though.

This is especially true for businesses who are reliant on receivables in respect to maintaining cash flow. Efficient management of this metric is necessary for businesses needing ample cash to fulfill their obligations. 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.

How the Average Collection Period Ratio Works

This average defines the relationship between your accounts receivable and your cash flow. This result means that it takes ABC Retailers, on average, 30.42 days to collect payments from their customers after a credit sale. This information can help the company identify its efficiency in managing credit and collecting receivables, and compare it with industry benchmarks or competitors. A shorter average collection period is generally preferred, as it indicates a faster cash conversion cycle and better cash flow management. When one is determined to find out how to find the average collection period, it is often easiest to start with this combined full formula. This allows for learning how to calculate average collection period and how to calculate average accounts receivable.

• Your customers will likely rely on the postal service for sending you their payment.
• While you may state on the invoice itself that you expect them to be paid in a certain timeframe – say, three weeks – the reality might be vastly different, for better or worse.
• A shorter average collection period indicates that the company is more efficient in collecting its receivables, while a longer period may indicate potential issues with cash flow or credit management.
• When bill payments are delayed, your cash reserve will deteriorate, and you will have low or zero access to funds.
• Efficient management of this metric is necessary for businesses needing ample cash to fulfill their obligations.

We’ll use the ending A/R balance for our calculations here and assume the number of days in the period is 365 days. However, using the average balance creates the need for more historical reference data. Therefore, the working capital metric is considered to be a measure of What is the average collection period? liquidity risk. Access and download collection of free Templates to help power your productivity and performance. A former editor of the «North Park University Press,» his work has appeared at scientific conferences and online, covering health, business and home repair.

What Are the Consequences of a Credit Policy That Is Too Strict?

A shorter average collection period indicates that the company is more efficient in collecting its receivables, while a longer period may indicate potential issues with cash flow or credit management. One example of average collection period is the time it takes for a company to collect payments from its customers on average. This is calculated by dividing the total amount of credit sales by the average daily credit sales. This gives you the number of days it takes to collect payments on average. Accounts receivable turnover ratio is calculated by dividing total net credit sales by average accounts receivable. A common accounts receivable collection period formula involves trying to find the accounts receivable turnover ratio or DSO (days sales outstanding).

According to the car lot’s balance sheet, the sales revenue for this year is $18,250. Because it represents an average, customers who pay very early or extremely late can skew your results. Monitoring your average collection period regularly can help you spot problem accounts before they become uncollectible.

How to calculate average collection period for accounts receivable?

However, an ongoing evaluation of the outstanding collection period directly affects the organization’s cash flows. When calculating average collection period, ensure the same timeframe is being used for both net credit sales and average receivables. For example, if analyzing a company’s full year income statement, the beginning and ending receivable balances pulled from the balance sheet must match the same period.

• Also, remember that there is a difference between net sales and net credit sales.
• We can also compare the company’s credit policy with the competitors on the average days taken by the company from credit sale to the collection.
• The average collection period does not hold much value as a stand-alone figure.
• A shorter ACP indicates that a company is able to collect payments more quickly, which is a sign of a healthy liquidity position.

Conversely, when sales and/or the mix of customers is changing dramatically, this measure can be expected to vary substantially over time. The average collection period is the average number of days it takes for a credit sale to be collected. While a shorter average collection period is often better, too strict of credit terms may scare customers away.

The average collection period ratio is closely related to your accounts receivable turnover ratio. While the turnover ratio tells you how often you collect your accounts, the collection period ratio tells you how long it takes you to collect accounts. You can also keep track of payments with visual reports, allowing you to manage outstanding invoices proactively. The average collection period is calculated by taking the average amount of time it takes a company to receive payments on their accounts receivable (AR) and dividing it by the net Credit Sales.

In this article, we explore what the average collection period is, its formula, how to calculate the average collection period, and the significance it holds for businesses. To address your average collection period, you first need a reliable source of data. When you log in to Versapay, you get a clear dashboard of the current status of all your receivables. Your entire team can access your customers’ entire payment history, giving you a clear picture of your collection efforts.

Global E-Invoicing and Payment Software

After the completion of this step, the cash paid to you is finally available for you to use. Your credit policy and credit terms can also be used to accelerate and improve your cash inflows. Your efforts to collect on your customers’ accounts also have a direct impact on accelerating and improving your cash flow. For one thing, to be meaningful, the ratio needs to be interpreted comparatively. If it’s decreasing in comparison then it means your accounts receivable are losing liquidity and you may need to take positive steps to reverse this trend.