How to Find the Average Collection Period
The average collection period is a crucial financial metric that businesses use to measure the efficiency of their receivables management. It provides insights into how quickly a company can collect its accounts receivable and how well it manages its cash flow. In this article, we will discuss how to find the average collection period and its importance for businesses.
Understanding the Average Collection Period
The average collection period, also known as the days sales outstanding (DSO), is the average number of days it takes for a company to collect payment from its customers after a sale has been made. This metric is essential for assessing the effectiveness of a company’s credit and collection policies. A lower average collection period indicates that a company is collecting payments more quickly, while a higher average collection period suggests that there may be inefficiencies in the collection process.
Calculating the Average Collection Period
To calculate the average collection period, you will need two pieces of information: the total accounts receivable and the net credit sales over a specific period. Here’s how to find the average collection period:
1. Determine the total accounts receivable at the end of the period you’re analyzing.
2. Calculate the net credit sales during the same period.
3. Divide the total accounts receivable by the net credit sales to get the average daily sales.
4. Divide the average daily sales by the number of days in the period to get the average collection period.
The formula for the average collection period is:
Average Collection Period = (Total Accounts Receivable / Net Credit Sales) Number of Days in the Period
Example
Let’s say a company has a total accounts receivable of $100,000 at the end of the year, and its net credit sales for the year were $1,000,000. The number of days in the year is 365.
Average Daily Sales = $100,000 / 365 = $273.97
Average Collection Period = ($273.97 / $1,000,000) 365 = 100.06 days
This means that, on average, it takes the company 100.06 days to collect payment from its customers.
Importance of the Average Collection Period
The average collection period is an important metric for several reasons:
1. Cash Flow Management: A shorter average collection period means that a company can convert its receivables into cash more quickly, which can help improve cash flow and financial stability.
2. Credit Risk Assessment: By analyzing the average collection period, businesses can identify potential credit risks and adjust their credit policies accordingly.
3. Performance Comparison: Comparing the average collection period with industry benchmarks can help a company understand its performance relative to its peers.
Conclusion
Finding the average collection period is a straightforward process that requires basic financial data. By regularly monitoring this metric, businesses can make informed decisions about their credit and collection strategies, ultimately leading to improved financial health and stability.
