Average Collection Period

What is the Average Collection Period?

The average collection period is the time taken for a company to convert its credit sales (accounts receivables) in cash. Here’s the formula –

Average Collection Period

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For eg:
Source: Average Collection Period (wallstreetmojo.com)

Alternatively, the collection period can also be calculated as follows–

average collection period

Average Collection Period Example

Now we will take a practical example to illustrate the Average Collection period Calculation.

BIG Company decides to increase its credit term. The top management of the company requests the accountant to find out the collection period of the company in the current scenario.

Here is the information available to the accountant –

  • Net Credit Sales for the year – $150,000
  • Accounts Receivables at the beginning of the year – $20,000
  • Accounts Receivables at the end of the year – $30,000
  • As an accountant, find out the collection period of BIG Company.

In this example, first, we need to calculate the average accounts receivable.

  • The beginning and ending accounts receivables are $20,000 and $30,000, respectively.
  • The average accounts receivables for the year would be = ($20,000 + $30,000) / 2 = $50,000 / 2 = $25,000.

Now, we will find out the accounts receivables turnover ratio.

  • Accounts Receivable Turnover Ratio = Net Credit Sales / Average Accounts Receivable
  • Or, Accounts Receivable Turnover Ratio = $150,000 / $25,000 = 6.0x

Now, we can do the Average Collection period calculation

  • Collection Period = 365 / Accounts Receivable Turnover Ratio
  • Or, Collection Period= 365 / 6 = 61 days (approx.)

BIG Company can now change its credit term depending on its collection period.

Explanation of Average Collection Period Formula

The first formula is widely used by investors. The second formula is used when one doesn’t want to use the first formula.

In the first formula, we first need to find out the accounts receivable turnover ratio.

The formula for accounts receivable turnover ratio is –

accounts receivable turnover ratio

Once we know the accounts receivable turnover ratio, we would be able to do the Average Collection period calculation. All we need to do is to divide 365 by the accounts receivable turnover ratio.

In the second formula, all we need to do is find out the average accounts receivable per day (meaning average accounts receivable divided by 365) and also the average credit sales per day (meaning average credit sales divided by 365).

Use of Collection Period

Since the company needs to decide how much credit termCredit TermCredit Terms are the payment terms and conditions established by the lending party in exchange for the credit benefit. Examples include credit extended by suppliers to buyers of products with terms such as 3/15, net 60, which essentially implies that although the amount is due in 60 days, the customer can avail a 3% discount if they pay within 15 days.read more it should provide, it needs to know its collection period.

For example, if a company has a collection period of 40 days, it should provide the term as 30-35 days.

Knowing the collection period is very useful for any company.

There are two reasons for this –

  • First, a huge percentage of the company’s cash flow depends on the collection period.
  • Second, knowing the collection period beforehand helps a company decide means to collect the money that is due to the market.

The collection period may differ from company to company. A company may sell seasonally. In that case, the formula for the average collection period should be adjusted as per the necessity.

If for seasonal revenue, the company decides to the Collection period calculation for the whole year, it wouldn’t be just.

Average Collection Period Calculator

You can use the following Calculator

365 Days
Accounts Receivable Turnover Ratio
Average Collection Period Formula =
 

Average Collection Period Formula =
365 Days
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Accounts Receivable Turnover Ratio
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Average Collection Period Calculation in Excel (with excel Template)

Let us now do the same Average Collection period calculation example above in Excel.

This is very simple. You need to calculate the average accounts receivable, find out the accounts receivables turnover ratio. And then find the collection period.

First, we need to calculate the average accounts receivable.

average accounts receivable in excel

Now, we will find out the accounts receivables turnover ratio.

accounts receivables turnover ratio in excel

Now, we can calculate the collection period.

Total average collection period in excel

You can download this Excel template here – Average Collection Period Excel Template.

Average Collection Period Video

 

Recommended Articles

This has been a guide to the Average Collection Period. Here we discuss the formula to calculate the average collection period along with practical examples and downloadable excel templates. You may also have a look at these articles below for further readings

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