What Is Average Collection Period Ratio Formula and How to Calculate It

The ACP figure is also a good way to help businesses prepare an effective financial plan. You can consider things such as covering costs and scheduling potential expenses in order to facilitate growth. Let’s say that your small business recorded a year’s accounts receivable balance of $25,000. A company would use the ACP to ensure that they have enough cash available to meet their upcoming financial obligations. In the following example of the average collection period calculation, we’ll use two different methods. Companies prefer a lower average collection period over a higher one as it indicates that a business can efficiently collect its receivables.

What Is the Average Collection Period Formula?

The AR value measures a company’s liquidity, as it indicates its ability to cover short-term debts without relying on additional cash flows. The average receivables turnover is simply the average accounts receivable balance divided by net credit sales; the formula below is simply a more concise way of writing the formula. You need to calculate the average accounts receivable and find out the accounts receivables turnover ratio. The average collection period is the average period of time it takes for a firm to collect its accounts receivable.

Maintaining Liquidity

Sometimes, the rising trend may even signal the general worsening of the economy. A decreasing average collection period is generally the trend the main advantage of the plantwide overhead rate method is: companies like to see. Most of the time, this signals that the management has prioritized investment in collections and improved the collections processes.

You can calculate it by dividing your net credit sales and the average accounts receivable balance. Alternatively, check the receivables turnover ratio calculator, which may help you understand this metric. 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. The days sales outstanding calculation, also called the average collection period or days’ sales in receivables, measures the number of days it takes a company to collect cash from its credit sales. This calculation shows the liquidity and efficiency of a company’s collections department.

It may mean that the company isn’t as efficient as it needs to be when staying on time billing in xero invoicing top of collecting accounts receivable. However, the figure can also represent that the company offers more flexible payment terms when it comes to outstanding payments. 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. Even though a lower average collection period indicates faster payment collections, it isn’t always favorable. If customers feel that your credit terms are a bit too restrictive for their needs, it may impact your sales.

1. A company’s average collection period is indicative of the effectiveness of its AR management practices.
2. When calculating average collection period, ensure the same timeframe is being used for both net credit sales and average receivables.
3. According to a PYMNTS report, 88% of businesses automating their AR processes see a significant reduction in their DSO.
4. In the following example of the average collection period calculation, we’ll use two different methods.

How Is the Average Collection Period Calculated?

However, an ongoing evaluation of the outstanding collection period directly affects the organization’s cash flows. The days sales outstanding formula shows investors and creditors how well companies’ can collect cash from their customers. This ratio measures the number of days it takes a company to convert its sales into cash.

BIG Company can now change its credit term depending on its collection period. Whenever you have bills that you’re scheduled to pay, it’s important to keep track of how much you owe. You should always be monitoring your cash solvency so that you are sure you have enough capital available to take care of your financial responsibilities.

The value of a company’s ACP is used to evaluate the effectiveness of its AR management practices. In addition, properly managing the ACP and keeping it low is necessary for any company to operate smoothly. The money that these entities owe to a business when they purchase products or services is recorded on a company’s balance sheet, under accounts receivable or AR.