Accounts Receivable Days: What Is It, How to Calculate It, and More

Introduction

Accounts Receivable Days (A/R days) refer to the average time a customer takes to pay back a business for products or services purchased. This metric helps companies estimate their cash flow and plan for short-term future expenses. By measuring the A/R days, a company can identify whether its credit and collection processes are efficient or not.

For example, if a considerable number of customers default on their payments but eventually pay, then it’s time to make the collections process more proactive. On the other hand, if the business’s bad debt is piling up, the credit management process needs improvement.

To effectively manage A/R days, every A/R leader should have a comprehensive dashboard that offers visibility into all A/R processes. This allows them to keep track of key metrics and improve existing processes, ultimately reducing A/R days.

What are Accounts Receivable Days? 

Accounts Receivable Days (A/R days) is a metric that allows you to determine the average time it takes for your business to collect outstanding payments from customers. It signifies the duration an invoice remains unpaid before it is eventually settled. 

This accounts receivable days ratio serves as an important tool in assessing your business’s efficiency in handling short-term collections, providing crucial insights for financial analysis. By keeping track of A/R days, you gain a better understanding of your cash flow and can plan for upcoming expenses more effectively.

AR Days Calculation - How to calculate Accounts Receivable Days?

To calculate accounts receivable days, divide the accounts receivable by the total credit sales and then multiply the result by the number of days in the period you want to calculate (usually a year). This formula helps measure how long it takes for a company to collect payments from its customers.

Accounts receivable days formula:

Accounts Receivable Days = (Accounts Receivable / Total Credit Sales) x Number of Days

Calculating accounts receivable days – Example

Accounts Receivable Days = (Accounts Receivable/Total Revenue)*365

Company A has made a revenue of $5 million at the end of a year and has pending accounts receivable of $500,000.

Total Revenue = $5,000,000

Accounts Receivable = $500,000

Accounts Receivable Days = (Accounts Receivable/Total Revenue)*365

= (500,000/5,000,000)*365

= 0.1 * 365 = 36.5 days

So, the AR days for company A is 36.5 days. To interpret this metric, we will need details on the company’s industry and past data.

What Is a Good Accounts Receivable Days Number?

Accounts receivable days is a dynamic metric. There are several factors involved in calculating A/R days. A good or bad AR days number will depend on the industry, the company’s payment terms, and its past trends.

For example, nearly 50% of construction and oil companies get late payments, which leads to significantly higher A/R days when compared to retail or service companies. Thus, you cannot compare the A/R days of businesses operating in different industry segments.

A business’s payment terms also affect how long customers take to pay. If a company offers a 30-day credit period as per its credit policy, then an A/R day number of 37-38 days (25% above the limit) signifies some room for improvement. On the other hand, if the A/R days are much lower than the credit period, the credit terms might be too strict. Businesses can lose out on potential customers in such scenarios.

How to Analyze Your Accounts Receivable Days Metric?

Analyzing a company’s A/R days gives a detailed insight into its credit and collection process efficiency. If the metric is tracked and mapped to a chart, you can learn about the company’s ability to collect receivables and if it is affected by any particular pattern.

If there is a steady increase in the average time to receive payments, it might be necessary for a business to tighten its credit policy. However, if there is a continuous decline, lenient payment terms can be introduced to attract more customers. So, to make the most of the A/R days metric, it’s essential to pair it with other data.

In fact, understanding working capital metrics becomes even more intriguing when comparing companies within an industry. For instance, while comparing the key working capital metrics of automotive giants General Motors (GM) and Tesla, it was found that Tesla outperformed GM in DSO, highlighting its efficiency in collecting receivables. However, GM showcased a better cash conversion cycle driven by a higher DPO and lower DIO. For a detailed exploration of how these metrics shape the financial landscape of two industry leaders, check out the story of GM vs Tesla AR War.

How Can a Business Reduce Its Accounts Receivable Days?

Maintaining a good A/R days number is vital for the growth of any business. This number should not be too high or too low, as striking the perfect balance is crucial to maintaining a healthy cash flow. Let's explore five effective ways to reduce accounts receivable days and boost cash flow.

1. Implement stricter payment terms

A stringent credit policy is a great way to reduce A/R days. You can impose late payment charges to payment terms to make the process effective and prevent customers from defaulting on their due date. 

To get started, businesses should have a credit policy document in place. It can be considered a guide for the credit management and sales teams on issues relating to credit lines, risk exposure, payment waive-offs, etc. 

Business leaders looking to create or update the credit policy document can use a customizable template that outlines the broad sections that go into an effective credit policy document.

AI-powered Credit Risk Management Software helps automate credit scoring, approval workflows, real-time credit risk monitoring, and blocked order management. It helps you seamlessly implement your credit policy while reducing bad debt probability. 

2. Incentivize early payments

Offer a small discount to customers that pay with cash or within their credit period to bring down A/R days. It may not work for every customer, but you can motivate businesses with healthy cash flow that still delay payments till the last day without any reason to pay earlier.

By leveraging the Global E-Invoicing and Payment Software to automate the billing and payment processes, businesses can provide support for discount strategies and resolve disputes on a real-time basis.

3. Collect proactively

Businesses must identify accounts that are at risk and reach out to them before the due date. It will help cut down bad debt and reduce A/R days simultaneously. If a business wants to be proactive in collections, it should have an effective collections management strategy to identify accounts that show any signs of delaying payments. 

AI-based Collections Software helps businesses achieve 75% faster recovery through worklist prioritization enabled by advanced technologies. It also enables companies to improve collections efficiency with real-time visibility into health metrics like bad debt, DSO, and CEI.

4. Make it easy to pay

Sometimes, a lack of convenient payment methods is all that stops a customer from paying on time. By adding multiple payment options like credit cards, debit cards, electronic fund transfers, and checks, businesses can reduce the friction of payments. It can therefore reduce accounts receivable days of a business.

5. Automate the accounts receivable process

Automate credit and collections processes to make them more efficient and help reduce the AR days. A report from PYMNTS suggests that 88% of businesses that have automated their accounts receivable processes have seen a significant reduction in days sales outstanding (DSO or AR days).

To Conclude

Automating the A/R processes is a simple and effective way for businesses to improve the critical metric of Accounts Receivable Days. Doing it manually can be difficult and time-consuming, which is why leveraging technology can make a significant difference.

HighRadius’ AI-based Credit Risk Management Software and AI-based Collections Software allow businesses to track credit risk in real-time and enable up to 75% faster collections recovery. 

With features like AI-driven worklist prioritization, automated dunning abilities, integrated call management option for collection calls, and tracking of customer payment commitments, the software enhances receivables recovery and ensures DSO reduction.

Moreover, AI-powered credit risk management facilitates faster customer onboarding, auto-calculation of credit score and risk class, and much more, streamlining business processes and ensuring a smoother financial journey.

By embracing automation and advanced technology, businesses can strengthen their growth plans, conduct more accurate financial assessments, and manage debts more efficiently. 

FAQs

1. What are day sales in receivables?

The days sales in accounts receivable is a financial metric that measures the average number of days it takes for a company to collect payments from its customers after a sale has been made. It is calculated by dividing the total accounts receivable balance by the average daily sales.

2. How to calculate accounts receivable days on hand?

To calculate accounts receivable days, divide the accounts receivable by the total credit sales and then multiply the result by the number of days in the period you want to calculate (usually a year). This formula helps measure how long it takes for a company to collect payments from its customers.

3. What do high receivable days mean?

A high receivable day means that a company is inefficient in its collection processes and its payment terms might be too lenient. It could result in poor cash flow and hinder the growth of a business.

4. What causes an increase in accounts receivable days?

An increase in accounts receivable days can be caused by various factors such as extended credit terms, inefficient collection processes, customer payment delays, or an increase in sales on credit. These factors lengthen the time it takes for a company to collect payments from customers, leading to a higher accounts receivable turnover ratio.

5. Can receivable days be negative? 

Yes, accounts receivable can be negative. This occurs when the business owes more to creditors than it has available cash.

6. Is debtor days the same as receivable days?

No, debtor days, also known as the debtor collection period, are not the same as receivable days. They represent different financial metrics in relation to a company’s accounts receivable management.

7. What are day sales in receivables formula?

To find the number of days sales in receivables, divide the number of days in the year (using either 360 or 365) by the accounts receivable turnover ratio from the past year. This metric helps businesses understand how long it takes, on average, to collect payments from customers.