Companies compare their average collection period to their policies regarding customer payment terms. For example, having a collection period of 36.5 days on top of a 45-day company payment policy shows you’re efficient at collecting what customers owe. For example, say you want to find Light Up Electric’s average collection period ratio for January. At the beginning of the month, your beginning balance of accounts receivable was $42,000, and your ending accounts receivable balance was $51,000. Maintaining a proper average collection period is the way to receive payments on time and keep them at your disposal. If you lose sight of that, the accounts receivables can get out of hand anytime, leading to funds scarcity.
The receivables turnover value is the number of times that a company collects payments from customers per year. Typically, lower collection periods are preferred, as the shorter duration indicates more efficiency in credit collections. On the other hand, a high average collection period signals that a company might be taking too long to collect average collection period meaning payments on their accounts receivables. The average receivables turnover is simply the average accounts receivable balance divided by net credit sales; the formula below is simply a more concise way of writing the formula. Most modern businesses use accrual accounting, offering their customers the option to buy now and pay later.
How Companies Can Improve Their Average Collection Period
Companies prefer a lower average collection period over a higher one as it indicates that a business can efficiently collect its receivables. Average accounts receivable is the sum of starting and ending accounts receivable over a time period (such as monthly or quarterly), divided by two. Some industries typically experience higher accounts receivable days, like in the 50 to 70-day range.
- Knowing their payment patterns, you can modify and effectuate your communication with them and follow-up messages.
- This metric allows you to assess your liquidity, ensuring sufficient incoming cash to cover daily necessities and more.
- In specific terms, the average collection period denotes the days between when a customer buys the product and makes the full payment.
- This is primarily because companies rely significantly on the Accounts Receivables of the company.
- A company’s average collection period gives an insight into its AR health, credit terms, and cash flow.
- Banks must have a quick turnaround time for receivables because they rely on the income generated by these products.
However, as previously noted, there are repercussions to a very short collection time, such as losing customers to clients who have a more lenient collection period. These credit terms can range from 30 to 90 days, depending on the business’s track record and financial needs. By automating their AR process with HighRadius Autonomous Receivables, businesses can significantly improve their order to cash cycle. A high collection period often signals that a company is experiencing delays in receiving payments.
How is the average collection period calculated?
By forecasting cash flow from accounts receivable, businesses can proactively plan expenses, strategically navigating the dynamic landscape of credit sales. Accounts receivable is a business term used to describe money that entities owe to a company when they purchase goods and/or services. AR is listed on corporations’ balance sheets as current assets and measures their liquidity.