Suppose Tasty Bites Catering has an average collection period of 30 days, while Delicious Delights Catering has an average collection period of 45 days. Instead, review your average collection period frequently and over a longer duration, such as a year. A high collection period often signals that a company is experiencing delays in receiving payments. However, it’s important not to draw immediate conclusions from this metric alone. In the following example of the average collection period calculation, we’ll use two different methods. Clearly, it is crucial for a company to receive payment for goods or services rendered in a timely manner.

Additionally, It can be used as part of the analytical procedure which is part of the audit procedures of accounts receivable to assess how the company manage its receivable. A measurement of how well a business collects outstanding (unpaid) customer invoices. HighRadius offers a comprehensive, cloud-based solution to automate and streamline the Order to Cash (O2C) process for businesses. We’ll use the ending A/R balance for our calculations here and assume the number of days in the period is 365 days.

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. This type of evaluation, in business accounting, is known as accounts receivables turnover. You can calculate it by dividing your net credit sales and the average accounts receivable balance. Alternatively, check the receivables turnover ratio calculator, which may help you understand this metric.

Calculate average accounts receivable

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 cash flows. It is apparent from the results of both companies that XYZ Co. has performed better in collecting its account receivable balances as compared to ABC Co. For the comparison to be truly fair, other factors must also be considered such as the nature of both the businesses and the industries they operate in.

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While ACP holds significance, it doesn’t provide a complete standalone assessment. It’s essential to compare it with other key performance indicators (KPIs) for a clearer understanding. By submitting this form, you consent to receive email from Wall Street Prep and agree to our terms of use and privacy policy. We’ll now move to a modeling exercise, which you can access by filling out the form below.

In other words, it’s the average period of time between the “sale” or completion of services and when customers make payment for a given period. The average collection period is the average number of days between 1) the dates that credit sales were made, and 2) the dates that the money was received/collected from the customers. The average collection period is also referred to as the days’ sales in accounts receivable. The average collection period is the average number of days it takes for a credit sale to be collected. During this period, the company is awarding its customer a very short-term “loan”; the sooner the client can collect the loan, the earlier it will have the capital to use to grow its company or pay its invoices. While a shorter average collection period is often better, too strict of credit terms may scare customers away.

The result above shows that your average collection period is approximately 91 days. Below, you will find an example of how to calculate the average collection period. 🔎 You can also enter your terms of credit in our calculator to compare them with your average collection period. Once you have the required information, you can use our built-in calculator or the formula given in the next section to understand how to find the average collection period. To quantify how well your business handles the credit extended to your customers, you need to evaluate how long it takes to collect the outstanding debt throughout your accounting period.

1. Or multiply your annual accounts receivable balance by 365 and divide it by your annual net credit sales to calculate your average collection period in days for the entire year.
2. It can also offer pricing discounts for earlier payment (i.e. 2% discount if paid in 10 days).
3. Accounts receivable is a business term used to describe money that entities owe to a company when they purchase goods and/or services.
4. Furthermore, decisions regarding whether customers should be offered early settlement discounts can be made by considering the account receivable collection period of the business.

AccountingTools

It can also offer pricing discounts for earlier payment (i.e. 2% discount if paid in 10 days). The average collection period indicates the effectiveness of a firm’s accounts receivable management practices. It is very important for companies that heavily rely on their receivables when it comes to their cash flows. Businesses must manage their average collection period if they want to have enough cash on hand to fulfill their financial obligations. As noted above, the average collection period is calculated by dividing the average balance of AR by total net credit sales for the period, then multiplying the quotient by the number of days in the period. When analyzing average collection period, be mindful of the seasonality of the accounts debtor collection period formula receivable balances.

Or multiply your annual accounts receivable balance by 365 and divide it by your annual net credit sales to calculate your average collection period in days for the entire year. The average collection period is the time a company takes to convert its credit sales (accounts receivables) into cash. It provides liquidity to the company to meet its short-term needs or current expenses as and when they become due. The average receivables turnover is simply the average accounts receivable balance divided by net credit sales; the formula below is simply a more concise way of writing the formula. Understanding the debtor collection period is crucial for companies seeking to manage their cash flow effectively and minimize credit risks.

For example, for seasonal business, the sales of the business are always within a specific period. However, the account receivable balance at the end of the period may be unusually high or low depending on when the most recent seasonal sales took place. Moreover, the account receivable collection period is used in working capital management of a business.

For example, the account receivable collection period of a business can be used in the calculation of its cash operating cycle. Businesses can use this information to determine the length of time it takes them from the initial purchase of raw materials to final receipt of cash from the sales of their finished goods. The main source of cash generation for any business is through the sales it makes. Some businesses may make sales only for cash while other may allow their customers to pay later, known as credit sales. Either way, any cash generated from sales to customers, by the business, plays a vital role in the long-term stability and success of a business. Not only does it exemplify the ability of the business to generate sales but also demonstrate that the business can generate cash flows from its operations.