Average Collection Period Formula: What it Is and How to Use it?

When managing a business that extends credit, one of your biggest challenges is ensuring consistent cash flow. Accounts receivable can be a tricky area. The longer it takes to collect payments, the more your business's financial health is at risk. That's why the average collection period is a metric you can't afford to overlook.

This number provides a clear picture of how efficiently your business turns credit sales into cash. A long collection cycle can slow down operations and prevent growth, while a shorter one can free up capital for other priorities. 

In this article, we'll explain how to use the average collection period formula, the importance of calculating it, and share effective strategies to help you gain better control over your collection cycle.

Key Takeaways

• Average collection period: A metric that measures how long it takes your business to collect payments from customers on average.
• The formula: It's calculated by dividing your average accounts receivable by your net credit sales and multiplying by the number of days in a period.
• What it means: A lower number is generally better, indicating efficient collections and healthy cash flow. A higher number can signal problems with your processes.
• How to improve it: The most effective way to shorten the period is by moving from outdated manual methods to a modern, digital, and consumer-centric collections process.

What Is the Average Collection Period?

The average collection period is a key financial metric that measures how long, on average, it takes a business to collect payments after a sale has been made on credit. Essentially, it tells you the number of days your money is tied up in accounts receivable before it becomes available as cash.

A shorter collection period means your business is highly efficient at collecting payments. This is a positive sign, as it improves your cash flow and provides capital for operations and growth. Conversely, a longer collection period indicates potential inefficiencies in your collections process or issues with your customers' ability to pay. It can lead to cash flow problems and increase the risk of bad debt.

Struggling to manage long payment cycles and low collection rates? Learn how Tratta’s Reporting and Analytics can help you understand the root causes of payment delays and low conversions, so you can make data-driven decisions to improve your collection strategy.

How to Calculate the Average Collection Period?

Getting an accurate measure of your collection efficiency starts with a simple calculation. The formula for the average collection period gives you a clear and objective number to work with. It's the first step in understanding your current performance and identifying areas for improvement.

Average Collection Period Formula

The formula for the average collection period is:

Average Collection Period = (Average Accounts Receivable / Net Credit Sales) x Days in Period

• Average Accounts Receivable: The average amount of money owed to you by customers over a specific period.
• Net Credit Sales: Your total sales made on credit, minus any returns or allowances, over the same period.
• Days in Period: The number of days in the period being analyzed (e.g., 365 for a year, 90 for a quarter, or 30 for a month). 

This formula shows the relationship between your average receivables and your credit sales over the course of a period. By using this, you can pinpoint the exact number of days your business takes to turn a credit sale into cash.

Also Read: How To Calculate Average Net Accounts Receivable: Definition, Formula & Examples

Calculating Average Collection Period

To calculate your average collection period, you'll need two key figures from your financial statements: your average accounts receivable and your net credit sales.

1. Calculate Average Accounts Receivable: Add the accounts receivable balance from the beginning and end of the period (e.g., a fiscal year or quarter) and divide by two. 

For example, if your accounts receivable were $43,000 at the start of the period and $61,000 at the end, the calculation would be ($43,000 + $61,000) / 2, resulting in an average of $52,000.

2. Determine Net Credit Sales: This is the total value of sales made on credit during the same period. This figure is typically found on your income statement or sales ledger.
3. Apply the Formula: Divide your average accounts receivable by your net credit sales and then multiply the result by the days in period.

While 365 days is the common standard of days in the US for annual analysis, some may use 360 days for simplicity in monthly computations.

An Example in Practice

Consider a company with an average accounts receivable of $52,000 and annual net credit sales of $500,000. Using the formula:

Average Collection Period = (52,000 / 500,000) x 365 = 37.96 days

This means it takes nearly 38 days on average to collect payments for its credit sales.

What Does Your Average Collection Period Mean?

Calculating the average collection period is just the beginning. The real value lies in understanding what that number is telling you about the efficiency and financial health of your business. It's a key performance indicator that provides a clear look into your collections process.

Interpreting the Numbers

To understand if your average collection period is good or bad, you need to put it into context. Your goal is to keep this number as low as possible.

• A Healthy (Low) Number: This indicates your collections team is effective, your credit policies are sound, and your customers are paying on time. It suggests a strong, smooth process for resolving accounts and securing payments.
• A Concerning (High) Number: A high or increasing number suggests a breakdown in your collections process. This could be due to the following factors:
  • Inefficient Communication: Delays in sending out invoices or following up on past-due accounts.
  • Lenient Credit Policies: Approving credit to high-risk clients.
  • Customer Financial Issues: Your customers may be facing cash flow problems of their own.

Ultimately, your average collection period reveals the efficiency of your collection efforts. A low number validates your current processes, while a high number signals that it's time to investigate and address potential issues.

If delays in communication and a lack of flexible payment options are the main causes, Tratta’s Consumer Self-Service Platform can help solve them. It gives customers a secure, easy-to-use portal to manage their payments on their own terms, leading to faster resolutions and a healthier bottom line.

The Role of Benchmarks

Without a point of comparison, your average collection period is just a number. Benchmarking helps you evaluate your performance against industry standards and your own business goals.

• Industry Standards: Every industry has a typical collection cycle. Comparing your numbers to industry averages can help you see where you stand competitively. Are you collecting faster or slower than your peers?
• Your Own Credit Terms: The most important benchmark is your own payment policy. For example, if your business's policy has invoices that are due within 30 days, your average collection period should ideally be close to or under 30 days. However, if your average shoots up to 60 days, it signals a more serious issue, significantly impacting your business's cash flow.

By interpreting your average collection period in this light, you can move from simple calculation to actionable insight, helping you make smarter decisions about your collections strategy.

Why the Average Collection Period Matters?

Calculating and interpreting your average collection period is essential, but understanding its importance is what drives action. This single metric offers a powerful look into your business's financial stability and operational health, guiding you toward smarter decisions and a more robust financial future.

• Impacts Cash Flow: A low average collection period means you're converting credit sales into cash faster. This improves liquidity, giving you the money you need for daily operations, new investments, or handling unexpected expenses.
• Reduces Bad Debt Risk: The longer an account remains unpaid, the less likely it is to be collected. By shortening your collection period, you actively reduce the risk of accounts turning into bad debt, protecting your company's profits.
• Shows Operational Efficiency: A consistently low average collection period reflects a well-managed and effective collections process. This signals to investors and stakeholders that your business has sound financial controls in place.
• Guides Decision-Making: This metric can help you identify weaknesses in your current credit policies. If your collection period is too long, it may be a sign to tighten your credit standards or adjust your follow-up procedures.

Thus, tracking this metric allows you to move from a reactive approach to a proactive one, helping you manage your business's financial health more strategically.

Also Read: Average Collection Success Rates and Industry Insights

How to Improve Your Average Collection Period?

Knowing your average collection period is a crucial step, but the real challenge is taking action to shorten it. A faster collection cycle can free up cash, reduce risk, and improve your overall financial health. 

Here are some effective tips and strategies to help you improve your average collection period:

• Set Clear Credit Policies: Before a sale is made, establish clear and firm credit terms with your customers. Make sure they understand your payment expectations and any consequences for late payment.
• Automate Invoicing and Reminders: Manual processes are prone to delays and human error. Automate your invoicing to ensure bills are sent out promptly and accurately. Implement an automated reminder system for accounts that are approaching or past their due date.
• Establish a Systematic Follow-Up Process: Don't wait until an account is severely overdue to take action. Create a systematic process for following up with customers at specific intervals (e.g., 5 days before due, 1 day after due, etc.) to address any potential issues early.
• Improve Communication: The collections process can be frustrating for customers. Use clear, friendly, and respectful communication. Personalized messages and a consumer-centric approach can lead to quicker resolutions and a better customer experience.
• Offer Multiple Payment Options: The easier it is for a customer to pay, the faster you'll receive your money. Provide a variety of convenient payment methods, such as credit cards, ACH transfers, and online payment portals.

Many businesses find it challenging to offer these varied payment options and manage communication across different channels. See how Tratta’s Embedded Payments and Multilingual Payment IVR can help you create a secure, frictionless payment experience for every consumer.

Conclusion

Calculating the average collection period is a critical first step, but the real power lies in using that number to drive change. The most successful businesses in debt recovery and credit management don't just measure their efficiency; they actively improve it. The key isn't to work harder at old methods but to adopt new tools that make the entire process faster and more effective. 

If you’re ready to move beyond outdated methods and build a faster, more efficient collections cycle, platforms like Tratta can help. Our technology is designed to help you improve your average collection period by enabling consumers with a self-service payment experience, automating communication, and providing the data you need to succeed. 

Book a demo with Tratta today to learn how to transform your collections process and improve your cash flow.

FAQs

1. Is a low average collection period always a good thing? 

While a low number is generally a positive indicator, a collection period that is too short could suggest overly strict credit policies. This might deter potential customers and cause you to miss out on profitable sales opportunities. The goal is to find a balance that supports both efficient collections and business growth.

2. How does the average collection period differ from the accounts receivable turnover ratio? 

The average collection period measures the number of days it takes to collect money. The accounts receivable turnover ratio measures how many times a company collects its average receivables during a specific period. They are two different metrics that measure the same thing: collection efficiency.

3. What is a normal average collection period? 

There is no single "normal" number, as it varies widely by industry. For a business with 30-day payment terms, a number between 30 and 45 days is common. The best benchmark is your own company’s credit policy and the average for your specific industry.

4. Can an average collection period be too high? 

Yes. A high average collection period indicates that it's taking too long to collect payments. This can lead to serious cash flow problems, increase the risk of bad debt, and signal that your collections process is inefficient.

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