Average Collection Period Formula Calculator Excel template

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.

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.

1. 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.
2. Average accounts receivable per day can be calculated as average accounts receivable divided by 365, and Average credit sales per day can be calculated as average credit sales divided by 365.
3. Here are two important reasons why every business needs to keep an eye on their average collection period.
4. Otherwise, it may find itself falling short when it comes to paying its own debts.

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.

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.

Average Collection Period Example Calculation

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 https://simple-accounting.org/ 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.

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 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.

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.

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 nonprofit needs assessment 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.

Step 2: Calculate Your Average Collection Period

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.

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).

Formula for Average Collection Period

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.

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.

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.