Average Collection Period Overview, Importance, Formula

Companies need to strike a balance between receivable collection and maintaining good customer relationships, while ensuring adequate liquidity for operations and growth opportunities. Simply put, too long or too short an average collection period could put the long-term sustainability of the firm at risk. Therefore, effective and strategic management of the collection period is crucial for a company’s financial health and reputation. Certain industries naturally have a longer average collection period due to the norms set by industry standards.

In essence, the smoother the inflow of cash, the more smooth-running the company’s operations will likely be. The second component of the formula, Average Daily Sales (ADS), represents the average amount of daily sales generated by the business. This is calculated by dividing the total sales for a certain period by the number of days in that period.

Average Collection Period: Definition

Average collection period refers to the amount of time it takes for a business to receive payments owed by its clients in terms of accounts receivable (AR). Companies use the average collection period to make sure they have enough cash on hand to meet their financial obligations. The average collection period is an indicator of the effectiveness of a firm’s AR management practices and is an important metric for companies that rely heavily on receivables for their cash flows. The average collection period is calculated by dividing the net credit sales by the average accounts receivable, which gives the Accounts receivable turnover ratio. To determine the average collection period, divide 365 days by the accounts receivable turnover ratio. The term average collection period, or ACP, describes the amount of time taken by an organization to convert its accounts receivables to cash.

Average Collection Period is the time taken by a company to collect the account receivables (AR) from its customers. More specifically, it shows how long it takes a company to receive payments made on credit sales. So in order to figure out your ACP, you have to calculate average collection period meaning the average balance of accounts receivable for the year, then divide it by the total net sales for the year. 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.

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SuperMoney strives to provide a wide array of offers for our users, but our offers do not represent all financial services companies or products. As a result, it is best to compare the outcomes to industry standards and other competitors as they may vary depending on the company’s sector. In 2020 alone, more than 340 companies in the US filed for bankruptcy, with well-known names such as J.Crew, Hertz, Guitar Center, and Mallinckrodt.

Average daily sales give context to the Accounts Receivable figure by expressing it per day, allowing for a better comparison between different periods. This will shorten the average collection period, but will also likely reduce sales, as some customers take their business elsewhere. A lower average collection period usually means that a company has efficient collection practices, tight credit policies, or shorter payment terms. Receiving payments for goods and services on time plays a big part in maintaining liquidity. This enables companies to pay off short-term liabilities such as bills and trade payables.