For stakeholders like investors and creditors, this metric reflects financial stability and operational efficiency. A company that collects receivables faster than its peers demonstrates effective credit control, enhancing its appeal to investors. The average collection period evaluates a company’s credit management and customer payment habits. A longer period may signal difficulties in maintaining liquidity, potentially affecting the ability to meet obligations or invest in growth.

This article will explore the ACP formula, its significance, and how to use an ACP calculator to gain insights into your company’s cash flow management. Understanding the average collection period is crucial for businesses as it measures how efficiently they manage their accounts receivable. This metric indicates the average number of days it takes a company to collect payments from customers, directly impacting cash flow and financial planning. From the account receivable collection period of XYZ Co., it can be determined that the business has done exceptionally well when it comes to managing its account receivable balances. Not only have XYZ Co. managed to recover its balances within the 30 days credit period limit but also managed to trade receivables collection period formula do it 9 days (30 days – 21 days) before. Since the result is better than expected, XYZ Co. can also consider loosening its credit control policies to attract more sales.

The company’s top management requests the accountant to find out the company’s collection period in the current scenario. We will take a practical example to illustrate the average collection period for receivables. Although cash on hand is important to every business, some rely more on their cash flow than others. In addition to being limited to only credit sales, net credit sales exclude residual transactions that impact and often reduce sales amounts. This includes any discounts awarded to customers, product recalls or returns, or items reissued under warranty. This is because the company could not even get the cash from sales of its goods or services but lost them as expenses.

At its simplest, your company’s average collection period (also called average days receivable) is a number that tells you how long it generally takes your clients to pay you. Days sales outstanding is most useful when compared to the standard number of days that customers are allowed before payment is due. Thus, a DSO figure of 40 days might initially appear excellent, until you realize that the standard payment terms are only five days. DSO can also be compared to the industry standard, or to the average DSO for the top performers in the industry, to judge collection performance. The average collection period is often analyzed alongside other receivables metrics for a comprehensive view of credit and collections efficiency. Consider GreenTech Solutions, a fictional company specializing in eco-friendly technology products.

By assessing this period, companies can refine their credit policies and better understand customer payment behaviors. Account receivable collection period is also an indicator of the performance of the credit control department of a business. It is the duty of the credit control department of a business to ensure the collection period of the balances is lesser or at least the same as the agreed credit period. It can also be used to make decisions about factoring account receivables or outsourcing the credit control department. This can also easily be calculated in number of weeks or months if the credit periods are longer.

What is the difference between avg collection period and average payment period?

The Trade Receivables Collection Period is a vital financial metric that measures the average number of days a company takes to collect payments from its credit customers. This period is crucial for maintaining healthy cash flow and ensuring the business operations run smoothly. In this example, the graphic design business has an average receivables’ collection period of approximately 10 days. This means it takes around 10 days, on average, for the business to collect payments from their clients for credit sales. 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. 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.

Since the company needs to decide how much credit term it should provide, it needs to know its collection period. For example, the banking sector relies heavily on receivables because of the loans and mortgages that it offers to consumers. As it relies on income generated from these products, banks must have a short turnaround time for receivables. If they have lax collection procedures and policies in place, then income would drop, causing financial harm. However, it has many different uses and communicates several pieces of information.

Long collection days of credit sales will lead to insufficient cash to pay for these things. The collection period of credit sales is one of the most important key performance indicators that are closely and strictly monitored by the board of directors, CEO, and especially CFO. A lower average collection period is generally better, says Blackwood—because a lower figure indicates a shorter payment time. A fast collection period may not always be beneficial as it simply could mean that the company has strict payment rules in place. However, stricter collection requirements can end up turning some customers away, sending them to look for companies with the same goods or services and more lenient payment rules or better payment options.

• It is very important for companies that heavily rely on their receivables when it comes to their cash flows.
• Furthermore, decisions regarding whether customers should be offered early settlement discounts can be made by considering the account receivable collection period of the business.
• For the formulas above, average accounts receivable is calculated by taking the average of the beginning and ending balances of a given period.
• A low figure is considered best, since it means that a business is locking up less of its funds in accounts receivable, and so can use the funds for other purposes.

In this article, we will cover in detail about the account receivable collection period. This include the key definition, purpose, formula, explanation and analysis as well as its limitation. Before we jump into detail, let’s understand the overview as well as some key definition below. This metric should exclude cash sales (as those are not made on credit and therefore do not have a collection period). A good average collection period (ACP) is generally considered to be around 30 to 45 days. However, this can vary depending on the industry, company size, and payment terms.

This can impact a company’s liquidity and ability to meet its short-term obligations. A shorter collection period generally indicates that the company collects payments efficiently, contributing to a steady cash flow. A longer period may highlight inefficiencies or lenient credit terms, and could signal that the company should tighten its credit terms or improve its collections processes to ensure better liquidity. However, lower account receivable collection periods may also indicate aggressive credit control behaviors. For example, the credit control of the business calls their customers every day and threaten with legal action in case of failure to repay their balance within time. Businesses should ensure that it is kept at an optimal level while ensuring the satisfaction of the customers.

What are the main factors that increase the average collection period?

When there is a level of uncertainty in the economy, it’s important to protect your business by collecting your accounts receivable quickly. You may need to use a line of credit to pursue these opportunities, which means more interest to pay. If you don’t know how long it’s taking to collect your accounts receivables, it’s probably taking too long. In 2020, the company’s ending accounts receivable (A/R) balance was $20k, which grew to $24k in the subsequent year. Our platform automates reminders as well as internal or external escalations, and other collections actions, streamlining your collections process.

Related Terms

Using those assumptions, we can now calculate the average collection period by dividing A/R by the net credit sales in the corresponding period and multiplying by 365 days. Businesses often sell their products or services on credit, expecting to receive payment at a later date. Your average collection period tells you the number of accounts receivable days it takes after a credit sale to receive payment. Analysing the receivables collection period over time allows companies to identify trends and patterns. A consistent increase in the collection period may indicate a need to revise credit policies. In contrast, a decreasing collection period could signify improvements in credit management.

What is an Optimal Average Collection Period?

It means that Company ABC’s average collection period for the year is about 46 days. It is slightly high when you consider that most companies try to collect payments within 30 days. As we are aware of, most businesses rely on profits to show how they have performed.

• Thus, the average collection period signals the effectiveness of a company’s current credit policies and A/R collection practices.
• You can also compare your ratio to other similar businesses and decide whether or not you need to make improvements.
• Both equations will produce the same average collection period figure if you have the appropriate data.
• Similarly, businesses also need to generate cash to pay other business expenses such as rents, utilities, repair and maintenance, etc.
• In contrast, Clothing, Accessories, and Home Goods businesses report the lowest median DSOs among all sectors tracked by Upflow.
• The average collection period (ACP) is a key metric used to measure the efficiency of a company’s credit and collection process.

There’s no one-size-fits-all answer for what makes a “good” Average Collection Period. Ideally, a shorter collection period is generally preferred, as it indicates that the company collects receivables quickly and has efficient credit and collections practices. This typically suggests a well-managed cash flow and a more financially stable operation, as funds are being reinvested into the business sooner. The accounts receivable collection period compares the outstanding receivables of a business to its total sales.

How to Automate Your Accounts Receivable Process for Accelerated Cash Flow

The company wants to assess the account receivable outstanding at the end of December 2016. Discover ways to manage cash flow for your business with BDC’s free guide, Taking Control of Your Cash Flow. Longer collection times may be most challenging or risky for manufacturing companies, which often face higher costs at the start of the cash conversion cycle, says Blackwood. Clearly, it is crucial for a company to receive payment for goods or services rendered in a timely manner. 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.

If a customer does not pay within the promised time, the business can actively pursue to customer or else end up risking the recoverability of the balance. Another tool used to control account receivable balances is the account receivable collection period. Average collection period is calculated by dividing a company’s average accounts receivable (AR) balance by its net credit sales for a specific period, then multiplying the quotient by 365 days.

Once we know the accounts receivable turnover ratio, we can do the average collection period ratio. It implies that a business is able to collect payments from customers quickly, converting credit sales into cash promptly. It can set stricter credit terms that limit the number of days an invoice is allowed to be outstanding. This may also include limiting the number of clients it offers credit to in an effort to increase cash sales.