What is the Average Collection Period?

The average collection period is referred to as the time taken for a company to get payments owed by clients under the accounts receivable (AR) section. Businesses evaluate the average collection period to ensure they have an adequate amount of cash in hand to fulfil financial responsibilities.

This period can be calculated by dividing the average accounts balance that is receivable by the total net credit sales for the time. And then, the result is multiplied by the number of days counted in the period.

Basically, this Factor is extremely essential for those businesses that are heavily dependable on Receivables for cash flow.

Explaining the Average Collection Period

The average collection period delineates the average number of days between the date when the sale is made and the date when the buyer pays for it. For a company, this metric indicates the effectiveness of the practices used for the management of accounts receivable.

Business must regulate their average collection period to make sure that the operations are going efficiently. Generally, a lower average collection period is far more favourable in comparison to a higher average collection period.

A low period states that the company is collecting its payments quickly. And, there are no drawbacks to it as it indicates that the credit terms adhered to by a company are stringent. However, customers may look for lenient payment terms; thus, they might not be happy with the strict rules.

The calculation of the average balance of accounts receivable is done by adding both the opening and ending balances in the accounts receivable and then dividing the output with two.

Example of an Average Collection Period

To understand it better, let’s take an average collection period example here. Let’s suppose there is a firm that has an average accounts receivable balance of Rs. 1,00,000 for a year. The total net sales recorded during this period was Rs. 10,00,000. Now, to calculate the average collection period, this formula will be used:

((Rs. 1,00,000 ÷ Rs. 10,00,000) x 365)

Thus, the average collection period will be 36.5 days. Keeping in mind that most of the firms and organizations collect within 30 days, the round-figure of 36.5 days is not a bad one.

At the end of the day, collecting the receivables in a short and reasonable time period allows the firm to get enough time to pay off its responsibilities.