The average collection period is the average number of days it takes for a credit sale to be collected. While a shorter average collection period is often better, too strict of credit terms may scare customers away. Companies may also compare the average collection period with the credit terms extended to customers. For example, an average collection period of 25 days isn’t as concerning if invoices are issued with a net 30 due date.

Best average collection period for your business

1. Additionally, a lower number reduces the risk of customer defaults and likely reflects that payments are being made on time, depending on your billing cycle.
2. Thus, by neglecting their policies for managing accounts receivable, they can potentially have a severe financial deficit.
3. However, a very low APT can cause friction in your relationships with your suppliers.
4. For example, a cash flow coverage ratio of 1.5 means a company has $1.5 operating cash flow to cover $1 of interest expense.
5. It is calculated by dividing net credit sales by average accounts receivable.

It is calculated by dividing net credit sales by average accounts receivable. The average collection period is the time a company takes to convert its credit sales (accounts receivables) into cash. It provides liquidity to the company to meet its short-term needs or current expenses as and when they become due. To effectively monitor payments, operational staff need to have an overall view of outstanding receivables and be able to edit an aged trial balance easily. Software solutions such as Toucan enable you to integrate data from unlevered free cash flow multiple sites and track the most relevant treasury metrics. Using automation tools provides real-time data and visual representations of key metrics.

Do the KPIs give you the whole picture?

The best average collection period is about balancing between your business’s credit terms and your accounts receivables. Similarly, a steady cash flow is crucial in construction companies and real estate agencies, so they can pay their labor and salespeople working on hourly and daily wages in a timely manner. Also, construction of buildings and real estate sales take time and can be subject to delays. So, in this line of work, it’s best to bill customers at suitable intervals while keeping an eye on average sales. For example, financial institutions, i.e., banks, rely on accounts receivable because they offer their customers credit loans, installments, and mortgages.

Most modern businesses use accrual accounting, offering their customers the option to buy now and pay later. This process is typically done through invoicing which requires a company to set collection period parameters and deploy specific receivables procedures. While a “buy now, pay later” model theoretically seeks invoice definition to increase sales, the downside is it delays and creates some uncertainty for cash flow payments. As such, it can become more difficult to finance day-to-day operations or make future investments.

For the company, its average collection period figure can mean a few things. It may mean that the company isn’t as efficient as it needs to be when staying on 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. Once we know the accounts receivable turnover ratio, we can do the average collection period ratio. All we need to do is to divide 365 by the accounts receivable turnover ratio. It increases the cash inflow and proves the efficiency of company management in managing its clients.

Collections by Industries

Calculating the average collection period with average accounts receivable and total credit sales. According to PYMENTS’ report on automation, more than 70% of businesses reported that automation leads to improved cash flow, increased savings, and overall business growth. Today, CRM and other digital tools offer various functionalities to optimise billing and collection operations. For better management of your accounts receivable, remember to consult them regularly and to monitor them over time to detect any signs of weakness, whether they are cash management. If this company’s average collection period was longer—say, more than 60 days— then it would need to adopt a more aggressive collection policy to shorten that time frame. Otherwise, it may find itself falling short when it comes to paying its own debts.

Calculating the Average Collection Period

Every business has its average collection period standards, mainly based on its credit terms. 🔎 You can also enter your terms of credit in our calculator to compare them with your average collection period. Once you have the required information, you can use our built-in calculator or the formula given in the next section to understand how to find the average collection period. In this example, first, we need to calculate the average accounts receivable. The company’s top management requests the accountant to find out the company’s collection period in the current scenario.

A more extended average collection period also increases the chances of growing customer debt or accounts receivable (AR) going unpaid. Plus, the impact is greater for professional service companies, as you don’t have physical assets or products to fall back on to recuperate those losses. Or multiply your annual accounts receivable balance by 365 and divide it by your annual net credit sales to calculate your average collection period in days for the entire year. You need to calculate the average accounts receivable and find out the accounts receivables turnover ratio. The average collection period signifies the average duration a business requires to collect payments owed by clients or customers.