How to Calculate the Average Collection Period
When you’re setting up credit terms for your customers, you want to ensure that the average collection period is optimal. It will help you measure the performance of your collection efforts and see where improvement opportunities lie. Whether your collection period is low or high, knowing how to calculate the average will give you a better understanding of your company’s financial health. In addition, it will help you understand the impact of seasonal sales on the average collection period.
Calculating the average collection period
Calculating the average collection period of a company’s accounts receivables is an important part of business accounting. The average collection period relates the length of time it takes to collect payment from a customer. There are two main methods of computing the average collection period. The first method uses average accounts receivables as the inputs, while the second method uses net credit sales and accounts receivable turnover ratio.
When determining the average collection period, you should compare your company’s collection period to the average of all previous years. A shorter collection period is generally a sign that accounts receivables are less liquid. You can also compare your current average collection period to that of similar companies. This method can be useful in identifying trends in your accounts receivables. In this way, you can set clear expectations for your customers.
Another method is to use a formula that allows you to calculate the average collection period for a particular company. The formula used in this method can be customized to meet the unique needs of your business. By understanding the length of your company’s average collection period, you can better assess the state of your company’s cash flow and improve your collection process. It is also important to remember that a long collection period may indicate problems in the collection process. If you are a small or midsize business, it may be difficult to monitor collection rates in the short run due to seasonality.
Measuring the average collection period ratio
When you look at your financial reports, you can get a better understanding of your company’s receivables management by measuring the average collection period. This metric will give you a clearer picture of the state of your business’s cash flow, as well as any areas for improvement. Here’s how to calculate the average collection period ratio:
To calculate the average collection period ratio, divide the average accounts receivable for a particular period by the net credit sales in that same period. The average collection period ratio can be calculated for any time period, as long as the average accounts receivable and net credit sales span the same number of days. Keeping this in mind, you can apply the formula to any period. Once you have calculated the average collection period ratio, you can compare the performance of different departments.
Companies that calculate the average collection period have different goals. They want to be competitive with other companies and improve their collection rate. They want to reduce their overall payout time because they want to be able to collect money more quickly. However, buyers may perceive a company’s payment turnaround times to be too short and steer their business to competitors who have a longer turnaround time. Measuring the average collection period ratio is not a panacea for the credit problem, but it does serve as a good barometer against competitors.
Setting up optimal credit terms
Every business has its own standard for its average collection period. Getting paid quickly can be a strategic advantage and a financial advantage. Faster payment times make a business more attractive to investors and lenders. You can set your average collection period to be less than half of the credit terms. However, you should not go too far and set it above the industry average. This is important because a higher average collection period indicates that more customers are delinquent.
The average collection period ratio can help you determine what your business can realistically expect from customers. To calculate it, divide your net sales by your accounts receivables. Then, multiply that quotient by the number of days in a year. The average collection period will give you an idea of how efficient you are and how flexible your credit policy is. Once you know how long your average collection period is, you can adjust your credit terms accordingly.