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. The receivables collection period is a critical financial metric that represents the average period of time it takes for the company to collect outstanding accounts receivable. Monitoring collections is essential to maintaining a positive trend line in cash flows so as to easily meet future expenses and debt obligations. The average collection period, also known as the average collection period ratio (ACP), estimates the timeline a company can expect to collect its accounts receivable.
- Average collection period can inform you of how effective—or ineffective—your accounts receivable management practices are.
- Similarly, a steady cash flow is crucial in construction companies and real estate agencies, so they can timely pay their labor and salespeople working on hourly and daily wages.
- 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.
- In this example, the graphic design business has an average receivables’ collection period of approximately 10 days.
- However, using the average balance creates the need for more historical reference data.
- Generally, having a low average collection period is preferable since it indicates that the firm can collect its accounts receivables more efficiently.
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. 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.
It enables the company to maintain a level of liquidity, which allows it to pay for immediate expenses and to get a general idea of when it may be capable of making larger purchases. More specifically, the company’s credit sales should be used, but such specific information is not usually readily available. The average collection period is often not an externally required figure to be reported. The usefulness of average collection period is to inform management of its operations. This metric should exclude cash sales (as those are not made on credit and therefore do not have a collection period).
Without this, predicting future cash flows, demand, and liquidity of the business will be tough; therefore, planning expenses and investments will be a relatively complex task. Lastly, the average collection period is a metric to evaluate the current credit arrangements and whether changes should be made to improve the working capital cycle. These credit terms can range from 30 to 90 days, depending on the business’s track record and financial needs. The Average Collection Period Calculator is used to calculate the average collection period. According to a PYMNTS report, 88% of businesses automating their AR processes see a significant reduction in their DSO.
An alternative and more widely used way to calculate the average collection period is to divide the total number of days in a given period by the turnover ratio of receivables. 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. 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.
We’ll discuss how to analyze average collection period further in this article. 🔎 You can also enter your terms of credit in our calculator to compare them with your average collection period. Learn how QuickBooks small business accounting solutions can improve your invoicing processes, budgeting practices and more.
How to reduce your average collection period
The average collection period is the average number of days it takes for a credit sale to be collected. While a shorter average collection period is often better, too strict of credit terms may scare customers away. If this company’s average collection period was longer—say, more than 60 days— then it would need to adopt https://simple-accounting.org/ a more aggressive collection policy to shorten that time frame. Otherwise, it may find itself falling short when it comes to paying its own debts. The best way that a company can benefit is by consistently calculating its average collection period and using it over time to search for trends within its own business.
Your entire team can access your customers’ entire payment history, giving you a clear picture of your collection efforts. With an accounts receivable automation solution, you can automate tedious, time-consuming manual tasks within your AR workflow. For instance, with Versapay you can automatically send invoices once they’re generated in your ERP, getting them in your customers’ hands sooner and reducing the likelihood of invoice errors. 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. Set your expectations for payment, including when the client needs to pay you and the penalties for missing a payment. Transparent payment terms help ensure you get paid, and help your customers understand your billing process.
Thus, by neglecting their policies for managing accounts receivable, they can potentially have a severe financial deficit. Calculating average collection period with average accounts receivable and total credit sales. 💡 You can also use the same method to calculate your average collection period for a particular day by dividing your average amount of receivables with your total credit sales of that day. First and foremost, establishing your business’s average collection period gives you insight into the liquidity of your accounts receivable assets.
What Is Days Sales Outstanding (DSO): The Lifeline of Accounts Receivable
It can also offer pricing discounts for earlier payment (i.e. 2% discount if paid in 10 days). Alternatively and more commonly, the average collection period is denoted as the number of days of a period divided by the receivables turnover ratio. 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.
These issues have pushed businesses to further streamline their accounts receivable process by implementing several key metrics and procedures to maintain liquidity. The goal for most companies is to find the right balance in their credit policy. This should be fair and accommodating to customers while efficient and realistic to the firm. The average collection period can be used as a benchmark to compare the performance of two organizations because similar businesses should provide comparable financial measures. When businesses rely on a few large customers, they take on the risk of a delay in payment.
Receivables collection period formula
Here, we’ll take a closer look at the average collection period, how to calculate it and more. Because it represents an average, customers who pay very early or extremely late can skew your results. Liquidity is your business’s ability to convert assets into cash to pay your short-term liabilities or debts. In January, it took Light Up Electric almost seven days, on average, to collect outstanding receivables. This means Light Up Electric’s average collection period for the year is about 17 days. They have asked the Analyst to compute the Average collection period to analyze the current scenario.
How Can a Company Improve its Average Collection Period?
Remember, your resulting figure is as temperamental as the clients you serve, so it’s never a bad time to pull out the average collection period calculator and get an update on your status. Here is an average collection capital campaigns period calculator which estimates how quickly the company is able to collect on its accounts receivable. Enter the company’s Accounts Receivable and Revenues and the tool will estimate how quickly the company collects.
ACP can be found by multiplying the days in your accounting period by your average accounts receivable balance. Then, divide the result by the net credit sales to find the average collection period. 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.
Calculating the average number of days it’ll take to get paid allows you to assess the effectiveness of your credit policy. Ultimately, this will help you make more informed financial decisions for your small business. In general, a higher receivable turnover is better because it means customers pay their invoices on time. So Light Up Electric should compare its AR Turnover Ratio to the industry average to see how they’re doing. The average collection period is the average number of days it takes to collect payments from your customers. This metric tells you how long it takes to get paid by customers, and it can help ensure you have enough cash flow to pay employees, make loan payments, and pay other expenses.
Make payment terms clear on contracts and invoices, with due dates, acceptable payment methods and other key details included (i.e. “cheques are payable to X”). When you know your average collection period, you can compare your results to other businesses in your industry and see whether there’s room for improvement. In this article, we’ll show you how to calculate your company’s average collection period and give you some examples of how to use it. The average collection period can also be denoted as the Average days’ sales in accounts receivable. Generally, having a low average collection period is preferable since it indicates that the firm can collect its accounts receivables more efficiently. The average collection period figure allows a company to plan effectively for forthcoming costs.
