One of the important factors that highlight turnover and cash flow management is the average collection period. 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. However, if the shorter collection period is due to overly aggressive collection practices, it runs the risk of straining customer relationships, potentially leading to lost business. 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. In today’s business landscape, it’s common for most organizations to offer credit to their customers.

1. The average collection period emerges as a valuable metric to help in this endeavor.
2. The average collection period for account receivables tells you which client pays earlier and which prolongs dues.
3. It’s essential to compare it with other key performance indicators (KPIs) for a clearer understanding.
4. 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.

This means that, on average, it takes your company 91.25 days to collect payments from clients once services have been completed. 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.

Here are the ways to shorten the collection period without losing customers. Unless you run a finance-based business, accessing their financial statements is not possible for you. Yet, with the calculation of average collection period, you can predict and understand their creditworthiness. Average collection period analysis is needed here to know where you stand. You can tune your collection periods accordingly and align accounts receivables in order.

Average Accounts Receivables

The average collection period (ACP) is a metric that reveals the average time it takes for a company to collect payments from customers for credit sales. It measures the company’s efficiency in converting accounts receivable into cash. A company’s average collection period is a key indicator, offering a clear window into its AR health, credit terms, and cash flow. By forecasting cash flow from accounts receivable, businesses can proactively plan expenses, strategically navigating the dynamic landscape of credit sales. Accounts receivable turnover ratio describes how efficiently a business can collect a debt owed and maintain a credit policy.

Best average collection period for your business

The average collection period metric may also be called the days to sales ratio or the receivable days. Generally, the average collection period is an important internal metric used in the overall management of a company’s finances. The average collection period is used a few different ways to measure cash flow performance.

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. 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. 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 formula below is also used referred to as the xero pricing features reviews days sales receivable ratio.

Example of Average Collection Period Calculation

The average collection period must be monitored to ensure a company has enough cash available to take care of its near-term financial responsibilities. 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.

What is the Average Collection Period?

Your business is at risk when the average collection period score is constantly high. The average collection period for account receivables tells you which client pays earlier and which prolongs dues. Knowing their payment patterns, you can modify and effectuate your communication with them and follow-up messages. 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 bank overdraft in balance sheet (BDC), most businesses should have an average collection period of less than 60 days.

BIG Company can now change its credit term depending on its collection period. This is a threat as the company will always be behind and never have needed funds in stock to achieve its plans. The lesser the score is, the quicker you get the money in your account and vice versa.

It allows the business to maintain a good level of liquidity which allows it to pay for immediate expenses. It also allows the business to get a good idea of when it may be able to make larger, more important purchases. As many professional service businesses are aware, economic trends play a role in your collection period. Seasonal fluctuations impact payment behaviors, which in turn affect your average collection period.