While seeking payments and retaining customers, one can easily miss out on timings. Management may have decided to increase the staffing and technology support of the collections department, which should result in a reduction in the amount of overdue accounts receivable. The average receivables collection period can be managed within the credit terms set out to customers. Okay now let’s have a look at an example so you can see exactly how to calculate the average receivables in days.
Why Is a Lower Average Collection Period Better?
Companies prefer a lower average collection period over a higher one as it indicates that a business can efficiently collect its receivables.The drawback to this is that it may indicate the company’s credit terms are too strict. Stricter terms may result in a loss of customers to competitors with more lenient payment terms.
If a business’s average collection period is improving, but its liquidity is getting worse, then that means the business is having issues in other aspects of its business. This measure is important as it highlights how the company’s accounts receivables are being managed. If you need help establishing KPMs or automating essential accounts receivable collection processes, contact the professionals at Gaviti. We’ve got years of experience eliminating inefficiencies and improving business. For one thing, to be meaningful, the ratio needs to be interpreted comparatively.
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Nicole Bennett is the Senior Content Marketing Specialist at Versapay. She is passionate about telling compelling stories that drive real-world value for businesses and is a staunch supporter of the Oxford comma. Before joining Versapay, Nicole held various marketing roles in SaaS, financial services, and higher ed. That said, there’s always room average collection period formula for improvement, and bringing the number down even further will certainly improve your cash flow and benefit your business. Learn how QuickBooks small business accounting solutions can improve your invoicing processes, budgeting practices, and more. We’ll show you how to analyze your average collection period a little later on in this post.
- Days sales outstanding is a measure of the average number of days that it takes for a company to collect payment after a sale has been made.
- For example, the banking sector relies heavily on receivables because of the loans and mortgages that it offers to consumers.
- The average collection period is the average number of days it takes for a credit sale to be collected.
- This includes any discounts awarded to customers, product recalls or returns, or items re-issued under warranty.
- The lesser the score is, the quicker you get the money in your account and vice versa.
Full BioMichael Boyle is an experienced financial professional with more than 10 years working with financial planning, derivatives, equities, fixed income, project management, and analytics. Whether you’ve started a small business or are self-employed, bring your work to life with our helpful advice, tips and strategies. In other words, Light Up Electric “turned over”—i.e., converted its AR into cash—21 times during the year. Starting with the average AR balance gives you a better snapshot of the year. If you were to simply use your ending AR balance, your results might be skewed by a particularly large or small year-end balance. With the best trading courses, expert instructors, and a modern E-learning platform, we’re here to help you achieve your financial goals and make your dreams a reality.
What is the Average Collection Period?
Now that you have determined the average number of days that it takes to collect an accounts receivable, how do you use this information? Generally, a lower average collection period indicates that the company is collecting payments faster. The average collection period formula is simple, but it needs a few figures to make the calculation. The average collection period equation is determined by dividing the average credit sales by the net credit sales for that duration and then multiplying it by the fraction of days in that period.