What Is the Average Collection Period, and How To Calculate It?

By understanding the factors that influence this metric and implementing strategies to optimize it, businesses can ensure they have enough cash to meet financial obligations and invest in future growth. A shorter collection period indicates that your business is efficient at collecting payments, ensuring enough cash is on hand to cover operations. It also reflects effective credit policies and a well-managed accounts receivable process. On the other hand, a longer collection period can signal inefficiencies in the collections process or issues with payment delays, which might lead to liquidity challenges.

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• In simple terms, it measures how quickly your company turns accounts receivable into cash.
• Ideally, a shorter collection period is generally preferred, as it indicates that the company collects receivables quickly and has efficient credit and collections practices.
• Clearly, it is crucial for a company to receive payment for goods or services rendered in a timely manner.
• This metric indicates the average number of days it takes a company to collect payments from customers, directly impacting cash flow and financial planning.
• Instead, you can get more out of its value by using it as a comparative tool.
• ACP is best examined on a trend line, to see if there are any long-term changes.
• For example, offering net 30 terms instead of net 60 can help shorten the collection period.

The first thing to decide is the time period you want to calculate the average for. Many accountants will use a one-year period (365 days), or an accounting year (360 days). You can also calculate the ratio for shorter periods, such as a single month. By taking these steps, you can achieve a lower average collection period, improve short-term liquidity, and maintain a steady cash flow, positioning your business for sustained growth. This means your company’s locking requirements for tax exemption up less of its funds in accounts receivable, so the money can be used for other purposes.

How to Calculate Average Collection Period

For example, offering net 30 terms instead of net 60 can help shorten the collection period. Average Collection Period is a vital metric that gives insight into your company’s ability to convert credit sales into cash, impacting everything from liquidity to credit policy. In the first formula, we first need to determine the accounts receivable turnover ratio. Once a credit sale happens, the customers get a specific time limit to make the payment. Every company monitors this period and tries to keep it as short as possible so that the receivables do not remain blocked for a long time.

Average Collection Period: Formula, How It Works, and Example

It increases the cash inflow and proves the efficiency of company management in managing its clients. An organization that can collect payments faster or on time has strong collection practices and also has loyal customers. However, it also means that they follow a very strict collection procedure which may also drive away customers because they prefer suppliers who have more flexible credit terms. A shorter collection period suggests effective credit management, while a longer one might signal challenges in collecting debts.

Average collection period, sometimes referred to as days sales outstanding, is the average time that elapses between your company’s completion of services and the collection of payment from your customers. Once we know the accounts receivable turnover ratio, we can do the average collection period ratio. All we need to do is to divide 365 by the accounts receivable turnover ratio.

Companies may also compare the average collection period with the credit terms extended to customers. For example, an average collection period of 25 days isn’t as concerning if invoices are issued with a net 30 due date. However, an ongoing evaluation of the outstanding collection period directly affects the organization’s value relevance of accounting information cash flows.

Encourage customers to pay before the due date by providing discounts for early payments. For example, a 2% discount for payments made within 10 days can motivate clients to prioritize your invoices. Improve the efficiency of your accounts receivable department by implementing bookkeeping andaccounting differences regular payment reminders, automated invoicing, and consistent follow-ups. The time it typically takes to collect payment from your customers after you’ve delivered a product or services. The average collection period should be used in your financial model to accurately forecast how and when new customers will contribute to your cashflow. According to the Bank for Canadian Entrepreneurs (BDC), most businesses should have an average collection period of less than 60 days.

How Can a Company Improve Its Average Collection Period?

If this company’s average collection period was longer—say, more than 60 days— then it would need to adopt a more aggressive collection policy to shorten that time frame. Otherwise, it may find itself falling short when it comes to paying its own debts. This average collection period calculator estimates the average number of days it takes the company to collect its receivables within a fiscal year. There in in depth information on how this indicator is computed below the form.

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• For example, if a company has a collection period of 40 days, it should provide days.
• 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.
• By measuring how long it takes to collect payments from customers, this metric provides insights into your cash flow, short-term liquidity, and the effectiveness of your collections process.
• Average Collection Period is a vital metric that gives insight into your company’s ability to convert credit sales into cash, impacting everything from liquidity to credit policy.
• Average collection period, sometimes referred to as days sales outstanding, is the average time that elapses between your company’s completion of services and the collection of payment from your customers.
• Read how adopting automated cash application systems can enhance business operations.

Similar companies should produce similar financial metrics, so the average collection period can be used as a benchmark against another company’s performance. For the formulas above, average accounts receivable is calculated by taking the average of the beginning and ending balances of a given period. More sophisticated accounting reporting tools may be able to automate a company’s average accounts receivable over a given period by factoring in daily ending balances.

Factors Affecting the Average Collection Period

This is not a bad figure, considering most companies collect within 30 days. Collecting its receivables in a relatively short and reasonable period of time gives the company time to pay off its obligations. When analyzing average collection period, be mindful of the seasonality of the accounts receivable balances. For example, analyzing a peak month to a slow month may result in a very inconsistent average accounts receivable balance that may skew the calculated amount. Suppose the average account receivables per day of a grocery store is $50,000 while the average credit sales per day is $20,000. You likely collect some accounts much faster, while others remain overdue longer than average.

In the example that has been mentioned above, it can be seen that the average collection period is used for the internal decision-making of the company. Hence, the Average Collection Period can also be defined as an indicator that reflects the effectiveness, as well as the efficiency of the Account Receivable practices by the company. This is primarily because companies rely significantly on the Accounts Receivables of the company.

Detailed Explanation of Average Collection Period

Seasonal fluctuations impact payment behaviors, which in turn affect your average collection period. The average collection period is often analyzed alongside other receivables metrics for a comprehensive view of credit and collections efficiency. 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. This metric should exclude cash sales (as those are not made on credit and therefore do not have a collection period). However, this does not necessarily imply that companies should continue to push customers for quicker payments.

This is in stark contrast to sectors like Office & Facilities Management, where the inability to “remove” clients from services due to non-payment makes enforcing prompt collections more challenging. Also, keep in mind that the average collection period only tells part of the story. To really understand your accounts receivables, you need to look at this metric in tandem with related metrics like AR turnover, AR aging, days payable outstanding (DPO), and more. For instance, consumers and businesses often face financial constraints during recessions or economic instability.

Collection software like Kolleno offer comprehensive solutions for automating invoicing, tracking payments, and analyzing customer payment behaviors. With Kolleno, businesses can streamline their collections process and reduce outstanding invoices with ease. In most cases, a lower average collection period is generally better for business as it indicates faster cash turnover, which improves liquidity and reduces credit risk.