Average Collection Period Formula, How It Works, Example

Publicado Por Alfonso Moraleja Juárez el 12/04/2022

If customers feel that your credit terms are a bit too restrictive for their needs, it may impact your sales. Calculating the average collection period with average accounts receivable and total credit sales. This would show that your average collection period ratio of the year is around 46 days. Most businesses would aim for a lower average collection period due to the fact that most companies collect payments within 30 days. The average collection period, or ACP, refers to the amount of time it takes for a business to receive any payments that it is owed by its clients.

How Average Collection Periods Work

This calculation helps businesses understand how quickly they are collecting on invoices over a particular period, which is critical for short-term financial planning. The best average collection period is about balancing between your business’s credit terms and your accounts receivables. Once you have calculated your average collection period, you can compare it with the time frame given in your credit terms to understand your business needs better. 💡 To calculate the average value of receivables, sum the opening and closing balance of your required duration and divide it by 2. You can also open the Calculate average accounts receivable section of the calculator to find its value. Generally speaking, an average collection period under 45 days is considered good.

Reading Speed Calculator

So, instead of looking up formulas online, then doing the calculations yourself, you can let our free calculators do all the work for you. Any company facing decrease in average collection period should take appropriate actions to resolve with a view to increasing orders to become more profitable. HighRadius offers a comprehensive, cloud-based solution to automate and streamline the Order to Cash (O2C) process for businesses.

Track Payment Patterns

At the same time, the AR value can be found on the balance sheet, which provides a snapshot of a point in time. As such, it is acceptable to use the average balance of AR over the same period of time as covered in the income statement. To find the ACP value, you would need to divide a company’s AR by its net credit sales and multiply the result by the number of days in a year.

• It refers to how quickly the customers who bought goods on credit can pay back the supplier.
• When disputes occur, there is often a string of back and forth phone calls that draws out the process of coming to an agreement and getting paid.
• This formula provides insights into the average time it takes to convert receivables into cash, reflecting the efficiency of a company’s credit policies and collection efforts.
• If your goal is to collect within 30 days, then an average collection period of 27.38 would signal efficiency.

This would indicate more efficient, streamlined cash flow and higher liquidity, giving a company confidence to make quicker purchases and plan for larger expenses. There are numerous factors that can increase a company’s average collection period. This includes poor customer support, delayed or disorganized collections processes, difficulty managing a large customer base with multiple payment terms, and loose credit policies and credit terms. Additional factors are economic downturns, inflation, and lengthier standard industry collection periods. Accounts receivable turnover ratio describes how efficiently a business can collect a debt owed and maintain a credit policy.

Analyzing Credit Terms

There in in depth information on how this indicator is computed below the form. It helps businesses understand the effectiveness of their credit and collection policies, directly impacting their cash flow and operational efficiency. 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. Calculating the average collection period with accounts receivable turnover ratio.

With Mosaic you can automatically track your average collection period or days sales outstanding metric to see if your customers are paying according to your benchmarks. This will help your company nail its cash flow targets and ensure you don’t end up in a cash flow crunch. A lower average collection period indicates that a company’s accounts receivable collections process is fast, effective, and efficient, comparing deferred expenses vs prepaid expenses resulting in higher liquidity. If your average collection period is higher than you would like, this may signal challenges in unlocking working capital and hinder your business’ ability to meet its financial obligations. Slower collection times could result from clunky billing payment processes; or they might result from manual data entry errors or customers not being given adequate account transparency.

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. While at first glance a low average collection period may indicate higher efficiency, it could also indicate a too strict credit policy. 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. In the first formula, we first need to determine the accounts receivable turnover ratio.

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 essential financial metric empowers you to make informed assessments of your company’s liquidity and collection efficiency with precision. Yes, the ACP calculator can be used for different periods to compare changes and track improvements in your collection efficiency over time.

It increases the cash inflow and proves the efficiency of company management in managing its clients. An organization that can collect payments faster or on time has strong collection practices and also has loyal customers. However, it also means that they follow a very strict collection procedure which may also drive away customers because they prefer suppliers who have more flexible credit terms. 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.