How to Calculate Your Average Collection Period Ratio

Average collection period, sometimes referred to as days sales outstanding, is the average time that elapses between your company’s completion of services and the collection of payment from your customers. In this example, the graphic design business has an average receivables’ collection period of approximately 10 days. This means it takes around 10 days, on average, for the business to collect payments from their clients for credit sales.

The average collection period figure is also important from a timing perspective to help a company prepare an effective plan for covering costs and scheduling potential expenditures to further growth. Offer customers a range of payment options such as credit cards, direct deposits, and online payments. Consider breaking large balances into installments to receive partial payment sooner.

If the accounts receivable collection period is more extended than expected, this could indicate that customers don’t pay on time. It’s a good idea to review your balance sheet and credit terms to improve collection efforts. If they’re offering net 45 days, then they’re doing well at collecting payments on time. But if their credit policy is net 10 days, then their customers are taking almost three times as long to make payments on average.

What Is an Average Receivables Collection Period?

But most importantly, try to avoid credit sales altogether by billing upfront whenever possible to avoid cash flow issues. However, what constitutes a good collection period also depends on factors like industry norms, customer payment behaviour, and the business’s specific financial goals. Regular monitoring and benchmarking against industry standards can help determine and implement a good receivables’ collection period tailored to the circumstances. Here are a few of the ways Versapay’s Collaborative AR automation software helps bring down your average collection period, improve cash flow, and boost working capital.

Company size

As an alternative, the metric can also be calculated by dividing the number of days in a year by the company’s receivables turnover. The Average Collection Period represents the number of days that a company needs to collect cash payments from customers that paid on credit. Let’s say that Company ABC recorded a yearly accounts receivable balance of $25,000. A fast collection period may not always be beneficial as it simply could mean that the company has strict payment rules in place. However, stricter collection requirements can end up turning some customers away, sending them to look for companies with the same goods or services and more lenient payment rules or better payment options.

Ensure that their information is up-to-date and accurate, with all the payment data that the customer needs to make a prompt payment. Send professional invoices as soon as work is completed to start the clock on collections. Be sure to include clear payment terms and due dates to set expectations upfront. The accounts receivable balance can be found on the QuickBooks balance sheet for the last day of the measurement period.

So if your accounts receivable balance on January 31 was $40,000, you would input $40,000 for this step. We all agree that optimizing the collection process is critical to small business success. In 2020, the company’s ending accounts receivable (A/R) balance was $20k, which grew to $24k in the subsequent year.

Using the average collection period calculation

1. You’ll also learn proven tips for reducing your collection period through payment incentives, credit policies, and other best practices.
2. Companies prefer a lower average collection period over a higher one as it indicates that a business can efficiently collect its receivables.
3. Companies use the average collection period to make sure they have enough cash on hand to meet their financial obligations.
4. In this example, the graphic design business has an average receivables’ collection period of approximately 10 days.
5. This may also include limiting the number of clients it offers credit to in an effort to increase cash sales.
6. Be sure to include clear payment terms and due dates to set expectations upfront.
7. So if a company has an average accounts receivable balance for the year of $10,000 and total net sales of $100,000, then the average collection period would be (($10,000 ÷ $100,000) × 365), or 36.5 days.

Similarly, inflation also negatively impacts consumers and businesses, often resulting in longer average collection periods. 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. Using this calculation, you can discover how long it takes to collect from the time the invoice is issued to the time you get paid. If the number is on the high side, you could be having trouble collecting your accounts.

How To Calculate Accounts Receivable Collection Period

You can create memorized reports in QuickBooks that automatically calculate your average collection period each month or quarter. Beyond manual calculation, QuickBooks also offers automated reporting tools to consistently track average collection period over time. Monitoring DSO regularly helps identify collection issues before they become severe. If DSO rises substantially above your average, it may signal problems getting paid on time. Take steps to follow up with late paying customers to bring DSO back in line.

While a shorter average collection period is often better, too strict of credit terms may scare customers away. It can set stricter credit terms limiting the number of days an invoice is allowed to be outstanding. This may also include limiting the number of clients it offers credit to average collection period formula in an effort to increase cash sales. It can also offer pricing discounts for earlier payment (i.e. 2% discount if paid in 10 days).

Company A wants to know what their average collection period ratio is for the past year, calculated in average number of days. The average collection period can also be compared to days payable outstanding, which is the average time taken to pay suppliers. This means it takes approximately 91 days on average for the company to collect payment on its credit sales. Every industry and business will have its own appropriate average collection period.

1. Companies should aim to reduce their collection period as much as possible through efficient billing and collections practices.
2. When assessing whether your average collection period is good or bad, it’s important you consider the number of days outlined in your credit terms.
3. So, let’s say they ran the numbers and discovered that their average collection period ratio in 2019 was 27.98 days, and in 2020 was 56 days.
4. However, using the average balance creates the need for more historical reference data.
5. Average collection period, sometimes referred to as days sales outstanding, is the average time that elapses between your company’s completion of services and the collection of payment from your customers.

To really understand your accounts receivables, you need to look at this metric in tandem with related metrics like AR turnover, AR aging, days payable outstanding (DPO), and more. The receivables collection period ratio interpretation requires a comprehensive understanding of the company’s industry, business model, and credit policies. Suppose Company A’s leadership wants to determine the average collection period ratio for the last fiscal year. First, multiply the average accounts receivable by the number of days in the period.