Seasonal fluctuations impact payment behaviors, which in turn affect your average collection period. 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. 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. Companies should also consider leveraging cash collection technology to streamline their collection processes.
How to Calculate Your Average Collection Period
🔎 Another average collection period interpretation is days‘ sales in accounts receivable or the average collection period ratio. With the help of our average collection period calculator, you can track your accounts receivables, ensuring you have enough cash in hand to meet your alternate financial obligations. Upon dividing the receivables turnover ratio by 365, we arrive at the same implied collection periods for both 2020 and 2021 — confirming our prior calculations were correct. In the next part of our exercise, we’ll calculate the average collection period under the alternative approach of dividing the receivables turnover by the number of days in a year. In order to calculate the average collection period, the company’s accounts receivable (A/R) carrying values from its balance sheet are needed along with its revenue in the corresponding period.
- It implies that a business is able to collect payments from customers quickly, converting credit sales into cash promptly.
- Additionally, utilising online payment platforms and providing multiple payment options can facilitate faster and smoother transactions, reducing the collection period.
- Industries such as banking (specifically, lending) and real estate construction usually aim for a shorter average collection period as their cash flow relies heavily on accounts receivables.
How is the Average Collection Period Formula Derived?
Below, we outline the various implications of the collection period for an organisation. A company’s average collection period gives an insight into its AR health, credit terms, and cash flow. Without tracking the ACP, it will become difficult for businesses to plan for future expenses and projects. Here are two important reasons why every business needs to keep an eye on their average collection period. The average collection period emerges as a valuable metric to help in this endeavor. It stands as an essential financial metric that grants businesses insight into the speed at which they can convert credit sales into actual cash.
What is the Debtor Days Calculation?
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. However, the ideal number depends on the nature of your business, client relationships, and invoice period. This comparison includes the industry’s standard for the average collection period and the company’s historical performance. More specifically, the company’s credit sales should be used, but such specific information is not usually readily available. Furthermore, proactive and consistent communication with customers can significantly impact the collection period.
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. Collecting its receivables in a relatively short and reasonable period of time gives the company time to pay off its obligations. Account receivable represents all the balances receivable from the trade debtors of a business. These trade debtors of the business are its customers to whom sales are made on credit terms. Businesses choose the customers based on many requirements such as credit scores, history with the business or the importance of the customer to the business.
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. Let us now do the average collection period analysis calculation example above in Excel. 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. HighRadius’ AI-powered collections software helps prioritize worklists for the top 20% of customers and automates collections for 80% of long-tail customers.
For example, the banking sector relies heavily on receivables because of the 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.
Consider a small graphic design business that offers design services to clients on credit. They want to determine the average time it takes to collect payments from their clients. Factors such as the company’s credit policy, the efficiency of its billing and collections processes, economic conditions, and customers’ financial health all influence how quickly customer payments are received. 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.
By calculating and monitoring this metric, businesses can improve their collection processes, maintain healthy liquidity levels, and sustain financial stability. Implementing strategies to streamline credit management and enhance collection efficiency is essential for long-term business success. You need to calculate the average accounts receivable and find out the accounts receivables turnover ratio. So if a company has an average accounts receivable balance for the year of $10,000 and total net sales of $100,000, then the average collection period would be (($10,000 ÷ $100,000) × 365), or 36.5 days. In order to calculate the average collection period, divide the average balance of accounts receivable by the total net credit sales for the period. Then multiply the quotient by the total number of days during that specific period.
If customers feel that your credit terms are a bit too restrictive for their needs, it may impact your sales. For example, financial institutions, i.e., banks, rely on accounts receivable because they offer their customers credit loans, installments, and mortgages. 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.
The Average Collection Period represents the number of days that a company needs to collect cash payments from customers that paid on credit. It means that Company ABC’s average collection period for the year is about 46 debtor collection period formula days. It is slightly high when you consider that most companies try to collect payments within 30 days. This metric should exclude cash sales (as those are not made on credit and therefore do not have a collection period). As many professional service businesses are aware, economic trends play a role in your collection period.