Average Collection Period Definition, Importance, Formula

In specific terms, the average collection period denotes the days between when a customer buys the product and makes the full payment. This value is based on how quickly you collect payments from your customers. Average collection period analysis can throw light on many takeaways that will help you understand your company more.

Otherwise, it may find itself falling short when it comes to paying its own debts. According to the rules of average accounts receivables, that company would have converted its accounts receivables two times, as it received two times the figure of average receivables. The average collection period for accounts receivable does more good if done frequently and properly. Frequently conducting an average collection period analysis is important to ideate your collections strategy and improve liquidity. Management has decided to grant more credit to customers, perhaps in an effort to increase sales.

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Your business is at risk when the average collection period score is constantly high. Not every client coordinates when they struggle to pay fully every time. It also looks at your average across your entire customer base, so it won’t help you spot specific clients that might be at risk of default. You’ll need to monitor your accounts receivable aging report for that level of insight.

They can replace the 365 in the equation with the number of days they wish to measure. It is important to know the industry before judging an average collection period. Rosemary Carlson is a finance instructor, author, and consultant who has written about business and personal finance for The Balance since 2008.

Limitations of the Average Collection Period Ratio

On an average, the Jagriti Group of Companies collects the receivables in 40 Days. To calculate Average collection period, we need the Average Receivable Turnover and we can assume the Days in a year as 365. We have to calculate the Average collection period for Jagriti Group of Companies. If the company decides to do the Collection period calculation average collection period for the whole year for seasonal revenue, it wouldn’t be just. Second, knowing the collection period beforehand helps a company decide the means to collect the money due to the market. BIG Company can now change its credit term depending on its collection period. If the average A/R balances were used instead, we would require more historical data.

• 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.
• An increase in the average collection period can be indicative of any of the conditions noted below, relating to looser credit policy, a worsening economy, and reduced collection efforts.
• Therefore, the working capital metric is considered to be a measure of liquidity risk.
• If you have difficulty collecting customer payments, it’s tough to pay employees, make loan payments, and take care of other bills.

Getting a better grip on average collection period means getting a grip on two key components – average accounts receivable and net credit sales. Receivable Turnover Ratio or Debtor’s Turnover Ratio is an accounting measure used to measure how effective a company is in extending credit as well as collecting debts. The receivables turnover ratio is an activity ratio, measuring how efficiently a firm uses its assets. Maintaining a proper average collection period is the way to receive payments on time and keep them at your disposal. If you lose sight of that, the accounts receivables can get out of hand anytime, leading to funds scarcity.

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If it is higher than the credit policy, it means the company is not bringing in money as expected. This often means turning to debt collectors, repossession, or other expensive alternatives to recover the expected funds. The average collection period is a measurement of the average number of days that it takes a business to collect payments from sales that were made on credit. Businesses of many kinds allow customers to take possession of merchandise right away and then pay later, typically within 30 days. These types of payments are considered accounts receivable because a business is waiting to receive these payments on an account. Accounts receivable are an asset, or something a business owns or is owed.