Average Collection Period: How it Works + Calculator

In addition, it can be readily used to make short-term payments or obligations. 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. 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. You have to divide a company’s average accounts receivable balance by the net average collection period formula credit sales and then multiply the quotient into 365 days.

Step 1. Calculate average accounts receivable

But they only managed to collect $ 10,000, which is their accounts receivable balance. As you can see, it takes Devin approximately 31 days to collect cash from his customers on average. Every business has its average collection period standards, mainly based on its credit terms.

The average collection duration can be compared to industry norms and rival companies in order to assess their performance and make the required corrections. The efficient operation and viability of a business are dependent on maintaining a healthy average collection period in today’s cutthroat business environment. A company’s performance is compared to its rivals using the average collection period, individually or collectively. The average collection times serve as a good comparison because similar organizations would have comparable financial indicators.

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Such methods not only quicken cash inflows but also improve customer satisfaction by providing a smooth, professional transaction experience. Grey was previously the Director of Marketing for altLINE by The Southern Bank. For example, customers who pay within 15 days from the purchase date can make use of a 10% discount. A little tuning is always needed as a lower collection period can leave some customers dissatisfied. Expecting to pay quicker might appear like a stringent rule and push them to find alternative providers. Join the 50,000 accounts receivable professionals already getting our insights, best practices, and stories every month.

• 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.
• The average collection period is an indicator of the effectiveness of a firm’s AR management practices and is an important metric for companies that rely heavily on receivables for their cash flows.
• It allows the business to maintain a good level of liquidity which allows it to pay for immediate expenses.
• The average collection period figure is also important from a timing perspective to help a company prepare an effective plan for covering costs and scheduling potential expenditures to further growth.
• It’s vital that your accounts receivable team closely monitor this metric and keep it as low as possible.
• Alternatively and more commonly, the average collection period is denoted as the number of days of a period divided by the receivables turnover ratio.
• When calculating average collection period, ensure the same timeframe is being used for both net credit sales and average receivables.

Comparing your Average Collection Period against industry norms can be eye-opening. It places your results in the context of a broader economic landscape, showing you where you stand among peers. However, if it’s higher, there’s a chance that your policies are lax, exposing you to higher credit risk and slower cash inflow. The average collection period for accounts receivable does more good if done frequently and properly. Frequently conducting an average collection period analysis is important to ideate your collections strategy and improve liquidity. Average collection period analysis can throw light on many takeaways that will help you understand your company more.

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A short and precise turnaround time is required to generate ROI from such services (you can find more about this metric in the ROI calculator). Thus, by neglecting their policies for managing accounts receivable, they can potentially have a severe financial deficit. 💡 To calculate the average value of receivables, sum the opening and closing balance of your required duration and divide it by 2. You can also open the Calculate average accounts receivable section of the calculator to find its value. This is one of many accounts receivable KPIs we recommend tracking to better understand your AR performance.

Average collection period calculator

• To calculate your average accounts receivable, take the sum of your starting and ending receivables for a given period and divide this by two.
• Below, you will find an example of how to calculate the average collection period.
• The ratio is calculated by dividing the ending accounts receivable by the total credit sales for the period and multiplying it by the number of days in the period.
• Also, remember that there is a difference between net sales and net credit sales.
• For instance, if you’ve just had a major product rollout, your collection period might be artificially low due to an influx of cash.
• Carbon Collective partners with financial and climate experts to ensure the accuracy of our content.

In the following example of the average collection period calculation, we’ll use two different methods. Make things easy by connecting with your customers using an intuitive, cloud-based collaborative payment portal that empowers them to pay when and how they want. The quicker you can collect and convert your accounts receivable into cash, the better. We will take a practical example to illustrate the average collection period for receivables. The average collection period does not hold much value as a stand-alone figure.

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. The average collection period is the length of time it takes for a company to receive payment from its customers for accounts receivable (AR). This metric is critical for companies that rely on receivables to maintain their cash flow and meet financial obligations.

CFI is the global institution behind the financial modeling and valuation analyst FMVA® Designation. CFI is on a mission to enable anyone to be a great financial analyst and have a great career path. In order to help you advance your career, CFI has compiled many resources to assist you along the path. If the average A/R balances were used instead, we would require more historical data. We’ll use the ending A/R balance for our calculations here and assume the number of days in the period is 365 days.

Average Collection Period Formula, How It Works, Example

When you know the current balance of your account, you can schedule and plan your future expenses accordingly. While seeking payments and retaining customers, one can easily miss out on timings. To explain this better, let’s take a look at the hypothetical case of a company, ‘XYZ’.