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Average Collection Period: Definition & Formula

This document discusses the average collection period, which is a metric that measures how quickly a company receives payment after extending credit to customers. It is calculated by dividing a company's yearly accounts receivable balance by its yearly total net sales and multiplying by 365. The average collection period is important because it helps a company maintain liquidity and plan for future costs by understanding when cash from sales will be received. A lower average collection period means customers pay bills faster, which is better for the company's cash flow and ability to cover expenses. However, a very low period could indicate strict payment rules that hurt customer relationships.

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44 views1 page

Average Collection Period: Definition & Formula

This document discusses the average collection period, which is a metric that measures how quickly a company receives payment after extending credit to customers. It is calculated by dividing a company's yearly accounts receivable balance by its yearly total net sales and multiplying by 365. The average collection period is important because it helps a company maintain liquidity and plan for future costs by understanding when cash from sales will be received. A lower average collection period means customers pay bills faster, which is better for the company's cash flow and ability to cover expenses. However, a very low period could indicate strict payment rules that hurt customer relationships.

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2/8/2021 Average Collection Period - Overview, Importance, Formula

form of accounts receivable.


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Calculating the average collection period for any company
is important because it helps the company better
understand how e ciently it’s collecting the money it
needs to cover its expenditures.

The average collection period is calculated by dividing a


company’s yearly accounts receivable balance by its yearly
total net sales; this number is then multiplied by 365 to
generate a number in days.

Importance of the Average Collection Period

1. Maintain liquidity

Clearly, it is crucial for a company to receive payment for goods or


services rendered in a timely manner. It enables the company to
maintain a level of liquidity, which allows it to pay for immediate
expenses and to get a general idea of when it may be capable of making
larger purchases.

2. Plan for future costs and schedule potential expenditures

The average collection period gure is also important from a timing


perspective to help a company prepare an e ective plan for covering
costs and scheduling potential expenditures to further growth.

For obvious reasons, the smaller the average collection period is, the
better it is for the company. It means that a company’s clients take less
time to pay their bills. Another way to look at it is that a lower average
collection period means the company collects payment faster.

A fast collection period may not always be bene cial as it simply could
mean that the company has strict payment rules in place. The rules may

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