It enables the company to maintain a level of liquidity, which allows it to pay for immediate expenses and to get a general idea of when it may be capable of making larger purchases. In that case, the formula for the average collection period should be adjusted as needed. The company’s top management requests the accountant to find out the company’s collection period in the current scenario. We will take a practical example to illustrate the average collection period for receivables. As we’ve said before, the average collection period offers limited insights when analyzed in isolation. The number of debtor days should be compared to that of other companies in the same industry to see if it is unusually high or low.

For example, analyzing a peak month to a slow month by result in a very inconsistent average accounts receivable balance that may skew the calculated amount. Whereas Delicious Delights Catering’s longer collection period suggests potential challenges in collecting payments from customers. It might indicate a need for improvement in credit control practices or customer payment follow-ups, such as automated payment reminders, invoice tracking, and customer payment monitoring. They could also consider reviewing their credit policies and offering incentives to encourage faster payments. With Mosaic you can automatically track your average collection period or days sales outstanding metric to see if your customers are paying according to your benchmarks. This will help debtor collection period formula your company nail its cash flow targets and ensure you don’t end up in a cash flow crunch.

Step 3: Calculate the Average Collection Period

Moreover, the account receivable collection period of the business can also be checked against its competitors, other businesses in the same industry or the industry average as a whole. The average collection period amount of time that passes before a company collects its accounts receivable (AR). In other words, it refers to the time it takes, on average, for the company to receive payments it is owed from clients or customers.

CFI is the global institution behind the financial modeling and valuation analyst FMVA® Designation. CFI is on a mission to enable anyone to be a great financial analyst and have a great career path. In order to help you advance your career, CFI has compiled many resources to assist you along the path. The current dollar amount of open invoices, based on days since the invoice date. By benchmarking against the industry standard, a company can gauge easily whether the number is acceptable or if there is potential for improvement. If the average A/R balances were used instead, we would require more historical data.

From the account receivable collection period of XYZ Co., it can be determined that the business has done exceptionally well when it comes to managing its account receivable balances. Not only have XYZ Co. managed to recover its balances within the 30 days credit period limit but also managed to do it 9 days (30 days – 21 days) before. Since the result is better than expected, XYZ Co. can also consider loosening its credit control policies to attract more sales. Similarly, XYZ Co., had total sales of $80 million, out of which $60 million were credit sales during last year. The account receivable balance at the start of last year was $3 million while at the end of last year, the balance was $4 million. To calculate the account receivable collection period, the average account receivable balance must be calculated first.

Track Payment Patterns

1. The average collection period is calculated by dividing the net credit sales by the average accounts receivable, which gives the Accounts receivable turnover ratio.
2. However, it also means that they follow a very strict collection procedure which may also drive away customers because they prefer suppliers who have more flexible credit terms.
3. As you can see there is a heavy focus on financial modeling, finance, Excel, business valuation, budgeting/forecasting, PowerPoint presentations, accounting and business strategy.
4. 🔎 You can also enter your terms of credit in our calculator to compare them with your average collection period.
5. As noted above, the average collection period is calculated by dividing the average balance of AR by total net credit sales for the period, then multiplying the quotient by the number of days in the period.

This include the key definition, purpose, formula, explanation and analysis as well as its limitation. Before we jump into detail, let’s understand the overview as well as some key definition below. A good receivables collection period is one that reflects efficient credit and collection management for a business. While the ideal collection period varies across industries, a shorter collection period generally indicates a more favourable scenario. This article aims to delve into the concept of the receivables collection period, its calculation, interpretation, and analysis while providing insights into optimising this vital aspect of cash flow management. At the beginning of the year, your accounts receivable were at $5,000, which increased to $10,000 by year-end.

Importance of average collection period

Efficient cash flow management is important for any business’s financial stability and growth. One crucial aspect that can impede cash flow efficiency is a lengthy receivables collection period. When customers take longer than anticipated to settle their invoices, it can strain liquidity and hinder the ability to meet financial obligations. Average collection period refers to how long it typically takes to collect payment from your customers after you’ve delivered a product or services, i.e., accounts receivables.

How to Calculate Debtor Days

AR is listed on corporations’ balance sheets as current assets and measures their liquidity. As such, they indicate their ability to pay off their short-term debts without the need to rely on additional cash flows. The account receivable collection period may also produce non-realistic results for some types of businesses.

Any sales made to customers for credit must be kept in a separate account to make tracking them easier. As we are aware of, most businesses rely on profits to show how they have performed. However, the cash flows of a business can also give a lot of useful information about a business.