A company’s average collection period gives an insight into its AR health, credit terms, and cash flow. Without tracking the ACP, it will become difficult for businesses to plan for future expenses and projects. Here are a few reasons why businesses need to keep an eye on their average collection period.
The ACP gives a clear picture of a company’s collections scenario. Businesses can plan their expenses in advance by predicting the cash flow from their accounts receivable.
For example, if the average collection period of a company is 25 days and they have $500,000 in AR, which is 20 days old, then the rule of thumb would be to expect the payment to arrive within 1 week.
A low DSO is suitable for businesses. However, in some cases, things may play out differently.
If a company’s ACP is 15 days, but the industry standard is close to 30 days, it could be because the credit terms are too strict. In such cases, a business may lose out on potential customers to competitors with better credit policies.
The average collection period (ACP) is calculated by taking the ratio of the number of days in a year and the accounts receivable turnover ratio. The AR turnover is the ratio of a company’s net credit sales in a year and the average accounts receivables.
A company makes $150,000 in credit sales in a year. At the beginning of the year, the accounts receivable were $5,000, and at the end, it was $10,000.
Net Credit Sales = $150,000
Average Accounts Receivables = ($5,000+$10,000) / 2 = $7,500
Account Receivable Turnover Ratio = (Net Credit Sales / Average Accounts Receivables)
= ($150,000 / $7,500) = 20 times
Average Collection Period = (365 / Account Receivable Turnover Ratio)
= (365/20) = 18.25 days
Even though ACP is an important metric for every business, it doesn’t portray much as a standalone unit. A few other KPIs that a company needs to compare it with, to get a clear picture of what the ACP indicates. These include the industry standard of the average collections period and the company’s past performance.
By comparing with the industry standard, a company can understand whether its DSO is acceptable, or can be improved. At the same time, the company’s past performance gives an idea of whether the collection process of a business is improving over time.
The average collection period or DSO of a business is critical for its growth. If a company consistently has high ACP, there is a problem with its accounts receivable and collection process. By automating them with HighRadius Autonomous Receivables, businesses can significantly improve their order to cash cycle.
PYMNTS reports state that 88% of businesses automating their AR processes see a significant reduction in their DSO. Automation also helps reduce manual intervention in the collection processes, allows for proactively reaching out to customers, and assists in setting up appropriate credit limits.
Is your business suffering from a high DSO? Check out our tips to reduce days sales outstanding.
The average period to collect a receivable can vary widely between different companies and industries. For example, the median DSO for the machinery industry is 57 days, whereas, for the metals and mining industry, it’s 32 days.
An average collection period of 30 days for a company indicates that customers purchasing products or services on credit take around 30 days to clear pending accounts receivable.
To improve the average collection period, companies must become proactive in their collections approach. Automating the order to cash process to make it more efficient will also help reduce DSO.
The HighRadius RadiusOne AR Suite is a complete accounts receivable’s solution designed for mid-sized businesses to put their order-to-cash on auto-pilot with AI-powered solutions. It leverages automation to fast-track key accounts receivable functions including eInvoicing & Collections, Cash Reconciliation, and Credit Risk Management powered by RadiusOne AR Apps to improve productivity, maximize working capital, and enable faster cash conversion. Affordable, quick to deploy, and functionality-rich: it is pre-loaded with industry-specific best-practices and ready-to-plug with popular ERPs such as NetSuite and Sage Intacct. The HighRadius RadiusOne AR Suite is designed to automate labor-intensive processes while streamlining credit and collections activities for faster AR processing, better cash flow and improved profitability.
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