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What is Average Collection Period? (Formula & Interpretation)

15 April, 2022
5 min read
Patrick Petti, AVP, Value Optimization
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What you'll learn

  • What is Average Collection Period?
  • The importance of tracking Average Collection Period(ACP)
  • How to calculate ACP with an example?
  • How can businesses interpret their Average Collection Period?
CONTENT
Introduction
Why is it critical to track the average collection period?
How to calculate the average collection period with an example?
How to interpret the average collection period?
Wrapping Up
FAQs
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Introduction

The Average Collection Period (ACP) is the time taken by businesses to convert their Accounts Receivables (AR) to cash. ACP is commonly referred to as Days Sales Outstanding (DSO) and helps a business track if they will have enough cash to meet short-term financial requirements.

A high average collection period suggests that a company is taking too long to collect payments. However, it is difficult to conclude the same with just this metric. For example, if a company’s ACP is 50 days and they issue invoices with a due date of 60 days, then the ACP is reasonable, but if the same company sets a due date of 30 days, the ACP is very high.

Why is it critical to track the average collection period?

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.

1) Predict cash flow

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.

2) Analyze credit terms

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.

How to calculate the average collection period with an example?

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.

Average Collection Period Formula

Example

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.
So,
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

Calculate your business’s DSO with our excel template and get insights on how to improve it.

How to interpret the average collection period?

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.

Wrapping Up

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.

FAQs

1) What is the average period to collect a receivable?

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.

2) What does an average collection period of 30 days indicate for a company?

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.

3) How to reduce the average collection period?

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.

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