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. Calculating the average collection period with average accounts receivable and total credit sales. 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 pricing and charging the receivables do not remain blocked for a long time.
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. In the long run, you can compare your average collection period with other businesses in the same field to observe your financial metrics and use them as a performance benchmark. The average number of days between making a sale on credit, and receiving its due payment, is called the average collection period.
Collecting its receivables in a relatively short and reasonable period of time gives the company time to pay off its obligations. 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.
How to shorten your average collection period?
Many accounts receivable teams often stumble on how to calculate average collection period and what to make of it. It may mean that your business isn’t efficient enough when it comes to staying on top of collecting its accounts receivable. However, it can also show that your credit policy is one that offers more flexible credit terms. The time it typically takes to collect payment from your customers after you’ve delivered a product or services.
Learning how to calculate average collection period will help your accounts receivables team to find where they stand and take action to shorten their score. All these efforts will help you maintain a healthy cash flow, sustain business operations effectively, and reduce your risk of bad debt. But most importantly, try to avoid credit sales altogether by billing upfront whenever possible to avoid cash flow issues.
For example, the banking sector relies heavily on receivables because of the general accounting definition 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. For example, customers who pay within 15 days from the purchase date can make use of a 10% discount.
- The average collection period, or ACP, refers to the amount of time it takes for a business to receive any payments that it is owed by its clients.
- A company’s average collection period is indicative of the effectiveness of its AR management practices.
- Thus, by neglecting their policies for managing accounts receivable, they can potentially have a severe financial deficit.
- Similarly, inflation also negatively impacts consumers and businesses, often resulting in longer average collection periods.
How To Efficiently Manage Your Company’s Account Receivables
In that case, the formula for the average collection period should be adjusted as needed. Knowing the average collection period for receivables is very useful for any company. Companies prefer a lower average collection period over a higher one as it indicates that a business can efficiently collect its receivables.
What Is the Average Collection Period Formula?
To explain this better, let’s take a look at the hypothetical case of a company, ‘XYZ’. But they only managed to collect $ 10,000, which is their accounts receivable balance. This can potentially impact the cash flow of the business, leaving it with more or no money. One factor in deciding the liquidity flow of the business is the average collection period. It’s vital for companies to receive payment for goods or services in a timely manner.
Average Collection Period: Overview, Formula & Example
As a business owner, the average collection period figure can tell you a few things. Let’s say that your small business recorded a year’s accounts receivable balance of $25,000. With Mosaic, you can also get a real-time look into your billings and collections process. Since Mosaic offers an out of the box billings and collections template, you can automatically surface outstanding invoices by due date highlighting exactly where to focus your collection efforts.
