This period reflects the efficiency of a company’s credit policies and cash flow management. The Average Collection Period is a vital metric that provides valuable insights into a company’s ability to collect payments from customers. By calculating and monitoring this metric, businesses can make informed decisions about their credit policies, improve cash flow, and optimize their accounts receivable process. Regularly improving the Average Collection Period can contribute to a more efficient, profitable, and sustainable business in the long term. It reflects the company’s liquidity and ability to pay short-term debts without depending on additional cash flows.

Most businesses require invoices to be paid in about 30 days, so Company A’s average of 38 days means accounts are often overdue. A lower average, say around 26 days, would indicate collection is efficient and effective. This number is the total number of credit sales for the period, less payments you received. 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.

Accounts Receivable Solutions

Stricter credit policies typically lead to a shorter average collection period because they reduce the risk of lending to customers with poor creditworthiness. On the other hand, overly strict policies could deter potential customers, so it’s a delicate balance. The average collection period also affects a company’s liquidity and, by extension, its working capacity.

Treasury Management

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• Collection software like Kolleno offer comprehensive solutions for automating invoicing, tracking payments, and analyzing customer payment behaviors.
• It can help identify potential problems in the company’s credit policies if, for instance, the average collection period is trending upward over time.
• On the contrary, if her result is higher than the local market, she might want to think about adjusting the terms of payment in their lease to make sure they are paid in a more timely manner.

It stands as an essential financial metric that grants businesses insight into the speed at which they can convert credit sales into actual cash. There are numerous factors that can increase a company’s average collection period. This includes poor customer support, delayed or disorganized collections processes, difficulty managing a large customer base with multiple payment terms, and loose credit policies and credit terms. Additional factors are economic downturns, inflation, and lengthier standard industry collection periods. Another method is to use a formula that allows you to calculate the average collection period for a particular company.

Utilizing the average collection period metric to skyrocket your cash flow

Although cash on hand is important to every business, some rely more on their cash flow than others. In addition to being limited to only credit sales, net credit sales exclude residual transactions that impact and often reduce sales amounts. This includes any discounts awarded to customers, product recalls or returns, or items reissued under warranty.

Then multiply the quotient by the total number of days during that specific period. The average collection period is an accounting metric used to represent the average number of days between a credit sale date and the date when the purchaser remits payment. A company’s average collection period is indicative of the effectiveness of its AR management practices. Businesses must be able to manage their average collection period to operate smoothly. Choosing the right tools can make all the difference in managing your accounts receivable efficiently.

How does the average collection period impact a company’s cash flow and liquidity?

All we need to do is to divide 365 by the accounts receivable turnover ratio. The best way that a collection period ratio company can benefit is by consistently calculating its average collection period and using it over time to search for trends within its own business. The average collection period may also be used to compare one company with its competitors, either individually or grouped.

In 2020, the company’s ending accounts receivable (A/R) balance was $20k, which grew to $24k in the subsequent year. Let’s consider a hypothetical example to demonstrate the calculation and interpretation of the collection ratio. The quicker you can collect and convert your accounts receivable into cash, the better. Let us now do the average collection period analysis calculation example above in Excel. We will take a practical example to illustrate the average collection period for receivables.

• A low average collection period indicates that the organization collects payments faster.
• 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.
• Real estate and construction companies also rely on steady cash flows to pay for labor, services, and supplies.

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. Average collection period is calculated by dividing a company’s average accounts receivable (AR) balance by its net credit sales for a specific period, then multiplying the quotient by 365 days. If a company can collect the money in a fairly short amount of time, it gives them the cash flow they need for their expenses and operating costs.

The average collection period is closely related to the accounts turnover ratio, which is calculated by dividing total net sales by the average AR balance. 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.

Striking the right balance is key to maintaining healthy cash flow while attracting and retaining customers. The concept of the collection ratio has evolved with the development of modern accounting and financial management practices. Historically, the ability to predict and manage cash flow has been essential for business survival and growth. Faster payment times make a business more attractive to investors and lenders.

While a shorter average collection period is often better, it also may indicate that the company has credit terms that are too strict, which may scare customers away. Collecting its receivables in a relatively short and reasonable period of time gives the company time to pay off its obligations. Assess your credit policies to ensure you’re extending credit to reliable customers. Conduct credit checks on new clients and limit credit for those with a history of late payments. Review your credit terms to ensure they encourage timely payments while remaining competitive in your industry. For example, offering net 30 terms instead of net 60 can help shorten the collection period.

Accounts Receivable Turnover

Knowing the average collection period for receivables is very useful for any company. The company’s top management requests the accountant to find out the company’s collection period in the current scenario. Remember, effective financial management hinges on regularly evaluating and understanding key metrics like the Collection Ratio. It’s essential to consider the industry average and whether the nature of the business requires longer terms to remain competitive. Understanding the average collection period provides a company with several advantages. A “good” ACP depends on your industry, customer base, and how you’ve structured your payment terms.

If your average collection period was significantly longer than your target collection terms, that’s indicative of a need to improve your collections efforts. There are many ways you can improve your processes, ranging from simple—such as using collections email templates—to more transformative—like investing in accounts receivable automation software. It may mean that the company isn’t as efficient as it needs to be when staying on top of collecting accounts receivable. However, the figure can also represent that the company offers more flexible payment terms when it comes to outstanding payments. For the formulas above, average accounts receivable is calculated by taking the average of the beginning and ending balances of a given period.