Average Collection Period Formula & Calculator

Understanding the Average Collection Period

The average collection period refers to the typical number of days it takes for a business to receive payment after making a sale on credit. This metric is also commonly known as days' sales in accounts receivable. Monitoring this ratio is essential for ensuring timely payment collection, which provides the cash needed for various operational expenses and investments.

Why the Average Collection Period Matters

Evaluating how efficiently your business manages customer credit requires analyzing the speed of debt collection over an accounting period. This analysis is performed through accounts receivable turnover, a key concept in business accounting. You can determine this turnover by dividing your net credit sales by your average accounts receivable balance.

Steps to Calculate the Average Collection Period

To begin your calculation, you will need to gather three core pieces of information:

• Determine your average accounts receivable.
• Identify the total number of days in the period.
• Calculate the total net credit sales made during that timeframe.

The Average Collection Period Formula

The standard formula for calculating the average collection period is:

ACP = (AR × Days) / TCS

In this formula:

• ACP = Average Collection Period
• AR = Average Accounts Receivable
• TCS = Total Credit Sales

For an annual perspective, the formula adapts to:

ACP = (AR × 365) / TCS

Practical Calculation Example

Let's consider a practical example. Assume your business had average accounts receivable of $25,000 and total annual credit sales of $100,000.

Method 1: Using the Standard Formula

Multiply your average receivables by the number of days in the year:

$25,000 × 365 = $9,125,000

Then, divide this figure by your total credit sales:

$9,125,000 / $100,000 = 91.25 days

This indicates an average collection period of approximately 91 days.

Method 2: Using the Accounts Receivable Turnover Ratio

First, calculate the turnover ratio:

$100,000 / $25,000 = 4

This means your receivables turn over 4 times a year. Next, divide the number of days in the year by this ratio:

365 / 4 = 91.25 days

Both methods yield the same result.

Impact on Business Cash Flow

The average collection period directly influences a company's cash flow and liquidity. Industries like construction and real estate require steady cash flow to pay workers and agents promptly. Maintaining an optimal collection period ensures that cash is available to cover ongoing expenses and payroll.

Determining the Ideal Collection Period for Your Business

The optimal average collection period strikes a balance between your credit terms and actual collection performance. Ideally, the number of days customers take to pay should be less than or very close to your credit terms. A common benchmark suggests it should not exceed your credit terms by more than one-third.

For example, with standard 30-day credit terms, your average collection period should ideally not stretch beyond 40 days. You can calculate this margin by dividing your credit terms by 3 and adding it to the original term:

(30 / 3) + 30 = 40 days

A collection period lower than your credit terms signals positive cash flow, while a higher period indicates slower payments and may require policy review.

Note on Average Accounts Receivable: This is typically calculated as the average of the opening and closing balances for the period, providing a more accurate measure than a single point-in-time figure.