Average Collection Period: Formula, Examples, Ways to Improve August 24, 2021 – Posted in: Bookkeeping

According to income statement the Financial Executives Research Foundation (FERF) 2024 Working Capital Study, companies maintaining collection periods under 45 days achieve 40% better cash flow management. Understanding the average collection period (ACP) is crucial for businesses as it indicates the efficiency of a company’s credit and collection policies. This metric measures the average number of days it takes for a company to receive payments owed by its customers. A lower ACP suggests that a company is able to quickly collect its receivables, which is beneficial for its cash flow and overall financial health.

Zero-touch collections

• When there is a level of uncertainty in the economy, it’s important to protect your business by collecting your accounts receivable quickly.
• Find this number by totaling the accounts receivable at the start and at the end of the period.
• A balance must be struck between extending credit to drive sales and ensuring that receivables are collected in a timely manner to avoid cash flow disruptions.
• Invoice-level calculations and value-weighted differences can lead to variations in reported ACP, depending on how the data is aggregated.
• For example, a manufacturing company with $600,000 accounts receivable and $4,380,000 annual credit sales ($12,000 daily credit sales) has a credit period of 50 days.

Regularly calculating your average collection period ratio can prevent each invoice you send from becoming a part of that statistic. Otherwise, if you allow clients to regularly take too long to pay invoices, your business may not have the cash on hand to operate how you’d like and meet financial obligations. Another method is to use a formula that allows you to calculate the average collection period for a particular company. The formula used in this method can be customized to meet the unique needs of your business.

How Do Businesses Use the Average Collection Period Calculation?

It’s useful to compare a company’s ratio to that of its competitors or similar companies within its industry. Looking at a company’s ratio, relative to those of similar firms, will provide a more meaningful analysis of the company’s performance rather than viewing the number in isolation. For example, a company with a ratio of four, not inherently a “high” number, will appear to be performing considerably better if the average ratio for its industry is two. The financial data over the examined periods reveals several notable trends and fluctuations in key financial metrics. Working capital, expressed in millions of US dollars, shows significant variability with negative values across most years, indicating a deficit in current assets relative to current liabilities. Furthermore, proactive and consistent communication with customers can significantly impact the collection period.

Detailed reporting and customer management

Catching these small shifts before they become serious problems can save your business a lot of heartache. Trade associations, financial publications, and benchmarking tools like IBISWorld can help. By tracking your ACP monthly or quarterly, you create benchmarks that help you gauge your progress and see how you stack up against industry standards.

Calculating the average collection period

• A shorter average collection period indicates that a company is more efficient at collecting its accounts receivable.
• Meanwhile, an operations manager might focus on streamlining billing processes and improving invoice accuracy to prevent delays.
• This can be done by automating everything from communication and customer management to invoicing and collections.
• For example, a retail company reducing its ACP from 60 to 30 days increased its quick ratio from 1.2 to 1.8, demonstrating improved liquidity position.

The best average collection period is about balancing between your business’s credit terms How to Start a Bookkeeping Business and your accounts receivables. 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 (you can find more about this metric in the ROI calculator). Thus, by neglecting their policies for managing accounts receivable, they can potentially have a severe financial deficit. 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.