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The average collection period is the number of days, on average,that it takes a company to collect its credit accounts or its accounts receivables. In other words, this financial ratio is the average number of days required to convert receivables into cash. You also have to look at the company's credit policy. The average collection period should be compared with the firm's credit policy to see how well the firm is doing. If the average collection period, for example, is45 days, but the firm's credit policy is to collect its receivables in30 days, then the small business owner needs to take a look at the firm's credit policy. The formula to calculate average collection period is the following: Accounts Receivable/Credit Sales/365 = # Days In order to calculate average collection period, the number for accounts receivable comes from the company's balance sheet. Sales come from the income statement and are adjusted for credit sales. Sales are then divided by the number of days in a year to come up with average daily credit sales. The final result is a number of days, which is the number of days, on average, it takes a company's credit customers to pay their accounts. In order to interpret the average collection period ratio, you have to have comparative data. If you compare the average collection period to past years of company data and it is increasing, that means your accounts receivables aren't as liquid or aren't being converted to cash as quickly as in the past. If the ratio is decreasing, then customers are not only paying their credit accounts on time but faster than they have in the past.
First, let’s see the difference between receivables and accounts receivable.
Accounts receivable are usually current assets that arise from selling merchandise or providing services to customers on credit. Accounts receivable are also known as trade receivables.
Receivables is the term that refers to both trade receivables and nontrade receivables.
Nontrade receivables are receivables other than accounts receivable. Some examples of nontrade receivables include interest receivable, income tax receivable, insurance claims receivable, and receivables from employees.
The term ReceivablesCollection Period indicates the average time taken to collect Receivables. In other words, a reducing period of time is an indicator of increasing efficiency. It enables the enterprise to compare the real collection period with the granted/theoretical credit period.
When evaluating the amount of accounts receivable outstanding, it is best to compare the receivables to the sales activity of the business, in order to see the proportion of receivables to sales. This proportion can be expressed as the average number of days over which receivables are outstanding before they are paid, which is called the accounts receivable collection period or days sales outstanding. A low figure is considered best, since it means that a business is locking up less of its funds in accounts receivable, and so can use the funds for other purposes.
Number of days your receivables remain pending in the market is receivable collection period. Mostly organizations use this formula to calculate their average collection period.
Last12 months credit sales/365 =Average credit sales
Total receivable / average credit sales = Average collection period or Number of days outstanding
Average number of days a company take to collect its receivables.
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