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Understanding Average Collection Period

The average collection period formula calculates the number of days it takes a company to collect payment on credit sales. It is calculated by taking the number of days in a period (often 365) and dividing it by the receivables turnover ratio. A lower receivables turnover ratio, which occurs when using a shorter time period, results in a higher average collection period. The formula shows the percentage of time it takes to collect payments based on the credit sales made throughout the period.

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14 views2 pages

Understanding Average Collection Period

The average collection period formula calculates the number of days it takes a company to collect payment on credit sales. It is calculated by taking the number of days in a period (often 365) and dividing it by the receivables turnover ratio. A lower receivables turnover ratio, which occurs when using a shorter time period, results in a higher average collection period. The formula shows the percentage of time it takes to collect payments based on the credit sales made throughout the period.

Uploaded by

Rajesh Tipnis
Copyright
© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd

Average Collection Period

The average collection period formula is the number of days in a period


divided by the receivables turnover ratio.

The numerator of the average collection period formula shown at the top
of the page is 365 days. For many situations, an annual review of the
average collection period is considered. However, if the receivables
turnover is evaluated for a different time period, then the numerator
should reflect this same time period.

For example, if the receivables turnover for one year is 8, then the
average collection period would be 45.63 days. If the period considered
is instead for 180 days with a receivables turnover of 4.29, then the
average collection period would be 41.96 days. By the nature of the
formula, a company will have a lower receivables turnover when a
shorter time period is considered due to having a larger portion of its
revenues awaiting receipt in the short run.

How is the Average Collection Period Formula Derived?

In order to understand the concept of the average collection period


formula, one must first look at the accounts receivables turnover
formula of

The average collection period formula can be rewritten as the


numerator, 365 days, times the inverse of the denominator. This would
result in the formula

The 2nd portion of this formula is essentially the % of sales that is


awaiting payment. The % of sales awaiting payment is then used as the
% of time awaiting payment throughout the period. From here, the % of
time awaiting payment is converted into actual days by multiplying by
365.

It is important to consider that a company that has seasonal sales will


affect the outcome when using this formula. For example, a company
that sales mostly at the beginning of the period may show none or very
little payments awaiting receipt. Also, a company who sales mostly
towards the end of the period may show a very high amount of
receivables. Alterations of the formula may be required to adjust for
each company.

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