What is the Average Collection Period?
Calculation and Usage of the Average Collection Period
The average collection period of accounts receivable is the average number of days it takes to convert receivables into cash. It also marks the average number of days it takes customers to pay their credit accounts.
Liquidity of Accounts Receivables
The average collection period tells the business owner the liquidity of the firm's accounts receivables. It provides information about the company's credit policies. The business owner can evaluate how well the company's credit policy is working by evaluating the average collection period.
Here is the formula for calculating average collection period:
Average Collection Period (# of days) = Accounts Receivable/Credit Sales/365
ACP=$8,960/$215,600/365 = 15 days
This means that, on average, customers pay their credit accounts every 15 days. As a basis for comparison, further imagine that the year prior, average collection period for this company was 20 days. This means that it dropped by 5 days year over year, and the average collection period improved from the year prior.
Average Collection Period
The average collection period ratio, often shortened to "average collection period" is also referred to as the "ratio of days to sales outstanding." It is the average number of days it takes a company to collect its accounts receivable. In other words, this financial ratio is the average number of days required to convert receivables into cash. The mathematical formula to determine average collection ratio is simple but requires collecting some financial information first.
Average Collection Period Ratio Calculation
The formula for calculating the average collection period ratio is:
Days in Period x Average Accounts Receivable ÷ Net Credit Sales = Days to Collection
When using this average collection period ratio formula, the number of days can be a year (365) or a nominal accounting year (360) or any other period, so long as the other data -- average accounts receivable and net credit sales -- span the same number of days.
The average accounts receivable over the period can be determined by totaling the accounts receivable at the beginning of the period and the accounts receivable at the end of the period, then dividing by 2.
Most businesses regularly account for the accounts receivable outstanding, sometimes weekly and often monthly. For longer calculation periods, the beginning and ending figures for accounts receivable can be found in the company's income statements or by adding the monthly accounts receivable figures for the year, which can be found on the balance sheet.
Net credit sales are simply the total of all credit sales minus total returns for the period in question. In most cases, this net credit sales figure is also available from the company's balance sheet.
The result of the calculation is the average number of days between the time a credit sale is initiated until the credit balance is paid.