Average Collection Period Ratio: What Is It?

Some businesses, including the construction industry, have high average collection period ratios due to the nature of the business. The goal for a business is to have an average collection period of less than their credit policy. If a company offers 30 days of credit, their average collection period should be less than 30. If it is higher than the credit policy, it means the company is not bringing in money as expected.

• Conversely, a long ACP indicates that the company should tighten its credit policy and improve the management of accounts receivable to be able to meet its short-term obligations.
• Collaborative AR automation software lets you communicate directly with your customers in a shared cloud-based portal, helping you resolve these problems efficiently.
• This includes any discounts awarded to customers, product recalls or returns, or items re-issued under warranty.
• It is very important for companies that heavily rely on their receivables when it comes to their cash flows.
• The average collection period formula is simple, but it needs a few figures to make the calculation.

It is very important for companies that heavily rely on their receivables when it comes to their cash flows. Businesses must manage their average collection period if they want to have enough cash on hand to fulfill their financial obligations. 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.

How to calculate average collection period

Knowing the accounts receivable collection period helps businesses make more accurate projections of when money will be received. 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. The company needs to adjust its credit policies to lower the collection period down to a week and be able to meet its short-term obligations.

If the number is on the high side, you could be having trouble collecting your accounts. A high average Running Law Firm Bookkeeping: Consider the Industry Specifics in the Detailed Guide ratio could indicate trouble with your cash flows. Average collection period (ACP), also known as the ‘ratio of days to sales outstanding,’ is the average number of days the company takes to collect its payment after it makes a credit sale.

Average Collection Period Analysis & Use

The average collection period is calculated by dividing total average accounts receivable balance by the net credit sales for a given period. Key performance metrics such as accounts receivable turnover ratio can measure your business’s ability to collect payments in a timely manner, and is a reflection of how effective your credit terms are. You must first calculate the accounts receivable turnover, which tells you how many times customers pay their account within a year.

The company can change the collection policy to handle the business’s liquidity. The best way to see if there are any long-term changes in the measure is to look at it on a trend line. In a business with consistent sales and a stable customer mix, the average collection period should be fairly consistent from month to month. When sales and customer mix change dramatically, on the other hand, this metric is likely to fluctuate significantly over time. It can be used as a performance metric for the collections department manager.

What is the accounts receivable collection period?

If your average collection period is higher than you would like, this may signal challenges in unlocking working capital and hinder your business’ ability to meet its financial obligations. Slower collection times could result from clunky billing payment processes; or they might result from manual data entry errors or customers not being given adequate account transparency. However, a lower average collection period can also indicate that a company’s credit terms are too strict. A low average collection period figure doesn’t always indicate increased total net sales, especially if credit sale numbers are low.

Your entire team can access your customers’ entire payment history, giving you a clear picture of your collection efforts. When assessing whether your average collection period is good or bad, it’s important you consider the number of days outlined in your credit terms. While at first glance a low average collection period may indicate higher efficiency, it could also indicate a too strict credit policy.