Average Collection Period Calculator

If they have lax collection procedures and policies in place, then income would drop, causing financial harm. By analysing the collection period-related figures, businesses can identify areas for improvement and take corrective action to ensure a healthy financial position. Suppose Tasty Bites Catering has an average collection period of 30 days, while Delicious Delights Catering has an average collection period of 45 days. Join the 50,000 accounts receivable professionals already getting our insights, best practices, and stories every month.

This can lead to financial difficulties and closing down their business in the worst case. At the beginning of the year, your accounts receivable were at $5,000, which increased to $10,000 by year-end. A fast collection period may not always be beneficial as it simply could mean that the company has strict payment rules in place.

  1. 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.
  2. The quicker you can collect and convert your accounts receivable into cash, the better.
  3. The Average Collection Period represents the number of days that a company needs to collect cash payments from customers that paid on credit.
  4. Like most accounting metrics, you’ll need some context to determine how this number applies to your finances and collection efforts.

On average, it takes Light Up Electric just over 17 days to collect outstanding receivables. We have Opening and Closing accounts receivables Balances of $25,000 and $35,000 for the Anand Group of companies. The average collection period should be closely monitored so you know how your finances look, and how this impacts your ability to pay for bills and other liabilities. There’s a big difference between knowing you’re due to be paid $10,000 and safely having it in your business bank account.

Any higher – i.e., heading into 40 or more – and you might want to start considering the cause. 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. As noted above, the average collection period is calculated by dividing the average balance of AR by total net https://simple-accounting.org/ 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 receivable balances. For example, analyzing a peak month to a slow month by result in a very inconsistent average accounts receivable balance that may skew the calculated amount.

While at first glance a low average collection period may indicate higher efficiency, it could also indicate a too strict credit policy. Average collection period is the number of days between when a sale was made—or a service was delivered—and when you received payment for those goods or services. This metric determines short-term liquidity, which is how able your business is to pay its liabilities.

How Is the Average Collection Period Calculated?

The receivables collection period ratio interpretation requires a comprehensive understanding of the company’s industry, business model, and credit policies. By tracking this period, businesses can assess their ability to convert credit sales into cash and manage their cash flow effectively. Analysing and managing the receivables collection period is essential for maintaining a healthy financial position and optimising cash flow. This is one of many accounts receivable KPIs we recommend tracking to better understand your AR performance. And while no single metric will give you full insight into the success—or lack of success—of your collections effort, average collection period is critical to determining short-term liquidity.

GoCardless helps you automate payment collection, cutting down on the amount of admin your team needs to deal with when chasing invoices. Find out how GoCardless can help you with ad hoc payments or recurring payments. In some cases, this may be out of your control, such as a downturn in the economy which means everyone is struggling to find the funds needed to pay their bills. Alternatively, the issue may be entirely within your control, such as a finance team that isn’t prioritizing incoming payments, whether that means issuing an invoice or chasing them up. As a result, it is best to compare the outcomes to industry standards and other competitors as they may vary depending on the company’s sector. However, as previously noted, there are repercussions to a very short collection time, such as losing customers to clients who have a more lenient collection period.

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. Suppose a company generated $280k and $360k in net credit sales for the fiscal years ending 2020 and 2021, respectively. Companies prefer a lower average collection period over a higher one as it indicates that a business can efficiently collect its receivables. 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.

Significance and Use of Average Collection Period Formula

You can also consider charging late fees for overdue payments, either as a flat rate or a monthly finance charge, usually a percentage of the overdue amount. Like most accounting metrics, you’ll need some context to determine how this number applies to your finances and collection efforts. The average collection period is an important metric for keeping your cash flow strong and ensuring your collection policies are effective.

An increase in the receivables collection period can be a cause for concern, as it suggests potential issues in the cash flow cycle. For instance, a company may experience a higher number of customers with delayed payment patterns, indicating potential credit risks. Additionally, changes in economic conditions or industry dynamics can impact customer payment behaviour, leading to extended collection periods.

How to calculate your average receivables collection period ratio?

This can come in the form of securing a loan to acquire more long-term assets for expansion. Similarly, businesses allow customers to pay at a later date; this is recorded as trade receivables on the business’s balance sheet. These types of businesses rely on customers to pay in cash to ensure that they have enough liquidity to pay off their suppliers, lenders, employees, and other trade payables. 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.

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. Average collection period can inform you of how effective—or ineffective—your accounts receivable management practices are. It does so by helping you determine short-term liquidity, which is how able your business is to pay its liabilities. When assessing whether your average collection period is good or bad, it’s important you consider the number of days outlined in your credit terms.

Businesses can measure their average collection period by multiplying the days in the accounting period by their average accounts receivable balance. 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. Average Collection Period is the approximate amount of time that it takes for a business to receive payments owed, in terms of receivables, from its customers and clients.

Average Collection Period Formula

Let’s say that Company ABC recorded a yearly accounts receivable balance of $25,000. From 2020 to 2021, the average number of days needed by our hypothetical company to collect cash from credit sales declined from 26 days to 24 days, reflecting an improvement year-over-year (YoY). Instead of carrying out your collections processes manually, you can take advantage of accounts receivable automation software. Even better, when you opt for an AR automation solution that prioritizes customer collaboration, you can improve collection times even further by streamlining the way you handle disputes and queries. To calculate your average accounts receivable, take the sum of your starting and ending receivables for a given period and divide this by two.

A good receivables collection period is one that reflects efficient credit and collection management for a business. While the ideal collection period varies across industries, a shorter collection period generally indicates a more favourable scenario. Having this information readily available is crucial to operating a successful business. However, we recommend tracking a series of accounts receivable KPIs and to develop a system of reporting to more accurately—and repeatedly—gauge performance. Not all metrics work for all businesses, so having an abundance of performance indicators is more valuable than relying on a single number.

On average, the Jagriti Group of Companies collects the receivables in 40 Days. Now we can calculate the Average collection period for Jagriti Group of Companies using the formula below. For example, ABC wants to open up a new plant about raise grants to expand its business operations, including expenses such as market research, licensing, labor costs, and other overhead costs. Average collection period is a measurement of the number of days the firm takes to collect money owed.