With the help of our average collection period calculator, you can track your accounts receivables, ensuring you have enough cash in hand to meet your alternate financial obligations.

The following article will explain in detail what the average collection period formula is, how it is used, and how it affects your cash flow.

We hope this information will help you make more efficient policies for managing your accounts receivable, primarily if your business relies heavily on net receivables.

Average collection period definition

The average number of days between making a sale on credit, and receiving its due payment, is called the average collection period.

🔎 Another average collection period interpretation is days' sales in accounts receivable or the average collection period ratio.

You should monitor this metric to ensure your business collects payments in due time for other needs or expenses.

Also, you may compare your average collection period ratio with your terms of credit to help determine how practically feasible your credit terms are for your customers and improve the effectiveness of your credit and collection policies.

Importance of average collection period

To quantify how well your business handles the credit extended to your customers, you need to evaluate how long it takes to collect the outstanding debt throughout your accounting period.

This type of evaluation, in business accounting, is known as accounts receivables turnover. You can calculate it by dividing your net credit sales and the average accounts receivable balance.

How to calculate average collection period?

Before you can calculate the average collection period, you'll need the following core information:

  1. Average accounts receivable: Also called the amount of receivables or AR, which your business is owed within a particular duration.

  2. Number of days that are in the respective duration of your average amount of receivables.

  3. Total credit sales you've made in the same respective duration of your average amount of receivables.

Once you have the required information, you can use our built-in calculator or the formula given below to understand how to find the average collection period.

💡 To calculate the average value of receivables, sum the opening and closing balance of your required duration and divide it by 2.

Average accounts receivable = (opening balance + closing balance) / 2

🔎 You can also enter your terms of credit in our calculator to compare them with your average collection period.

To view this option in our calculator, please select the advanced mode.

Average collection period formula

Here's the average collection period formula:

  • ACP = AR × Days / TCS

where:

  • ACP – Average collection period;
  • AR – Accounts receivable; and
  • TCS – Total credit sales.
  1. Multiply the average accounts receivable with the respective number of days, for which you're calculating the average.

  2. Divide the result by the total amount of credit sales made during the respective period.

💡 You can also use the same method to calculate your average collection period for a particular day by dividing your average amount of receivables with your total credit sales of that day.

  • ACP = AR / TCS

Or multiply your annual accounts receivable balance by 365 and divide it by your annual net credit sales to calculate your average collection period in days for the entire year.

  • ACP = AR × 365 / TCS

Once you have calculated your average collection period, you can compare it with the time frame given in your credit terms to understand your business needs better.

Below you will find an example of how to calculate the average collection period.

Example of the average collection period

In the following example of the average collection period calculation, we'll use two different methods.

Let's assume your business made 100,000 USD in credit sales last year and your average accounts receivable were 25,000 USD.

Here, you can calculate your average collection period in two ways:

1. Calculating average collection period with average accounts receivable and total credit sales.

To calculate your average collection period, multiply your average accounts receivable with the number of days in the year, i.e.:

25,000 × 365 = 9,125,000

Now, divide it by your total credit sales:

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

The result above shows that your average collection period is approximately 91 days.

2. Calculating average collection period with accounts receivable turnover ratio.

First calculate your accounts receivable turnover ratio by dividing your net credit sales with your average accounts receivable, i.e.:

100,000 / 25,000 = 4

Thus, in this case, your accounts receivable turnover ratio is 4 times per year.

Now, to calculate your average collection period, divide the number of days in the year by your accounts receivable turnover ratio, i.e.:

365 / 4 = 91.25 days

The result above matches your previous calculation.

💡 By dividing your total credit sales with the number of days in a year, you can determine your daily average credit sales, i.e.:

  • 100,000 / 365 = 273.97 USD

And if you divide your average accounts receivable by your daily average credit sales, you get the average collection period, i.e.:

  • 25,000 / 273.97 = 91.25 days

How average collection period affects cash flow

In the following scenarios, you can see how the average collection period affects cash flow.

For example, financial institutions, i.e., banks, rely on accounts receivable because they offer their customers credit loans, installments, and mortgages. A short and precise turnaround time is required to generate ROI from such services. Thus, by neglecting their policies for managing accounts receivable, they can potentially have a severe financial deficit.

Similarly, a steady cash flow is crucial in construction companies and real estate agencies, so they can timely pay their labor and salespeople working on hourly and daily wages. Also, construction of buildings and real estate sales take time and can be subject to delays. So, in this line of work, it's best to bill customers at suitable intervals while keeping an eye on average sales.

💡 A simple average sale period formula is to divide your annual net sales by the number of months in a year, i.e.,

  • Annual net sales / 12

Best average collection period for your business

The best average collection period is about balancing between your business's credit terms and your accounts receivables.

In the best-case scenario, the average number of days your customers take to repay the due amount, i.e., your average collection period, should be less than, or very close to your credit terms, but no greater than a third of your credit terms.

For instance, if your customers have 30 days to pay their bills, their average collection ratio should not extend beyond 40 days. You can calculate this margin as follows:

Divide your terms of credit by 3 and then add it to your actual credit terms, i.e.,

  • (30)/3 + 30 = 40 days

If your average collection period is lower than your terms of credit, it shows a positive cash flow trend. But if this number is higher, it means fewer customers are paying on time, and you should look into it now to avoid any future setbacks. 📈

Every business has its average collection period standards, mainly based on its credit terms.

Even though a lower average collection period indicates faster payment collections, it isn't always favorable. If customers feel that your credit terms are a bit too restrictive for their needs, it may impact your sales.

Thus, you can set up optimal credit terms depending on your available funds. But keep your credit utilization ratio in check, so you don't go overboard.

In the long run, you can compare your average collection period with other businesses in the same field to observe your financial metrics and use them as a performance benchmark.

We hope you now have a thorough understanding of what the average collection period is and how to find an average collection period to offer credit terms that are best suited for both your business and your clients.

AbdulRafay Moeen
Calculation method:
Average accounts receivable
Duration
days
Average accounts receivable
$
Total credit sales
$
Average collection period
days
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