What is the Average Collection Period?

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

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

Average Collection Period Example

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

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

Here is the information available to the accountant –

  • Net Credit Sales for the year – $150,000Accounts Receivables at the beginning of the year – $20,000Accounts Receivables at the end of the year – $30,000As 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 ReceivableOr, 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 RatioOr, 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

Investors widely use the first formula. However, the second formula is used when one doesn’t want to use the first formula.

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

The formula for accounts receivable turnover ratio is –

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, we need to find out the average accounts receivable per day (meaning average accounts receivable divided by 365) and 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 the means to collect the money due to the market.

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

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

Average Collection Period Calculator

You can use the following Calculator

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 and find out the accounts receivables turnover ratio. And then find the collection period.

First, we need to calculate the average accounts receivable.

Now, we can calculate the collection period.

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

Average Collection Period Video

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

  • Return on Average Assets (ROAA)Return On Average Assets (ROAA)Return on Average Assets (ROAA) is a subset of the Return on Assets ratio. It is calculated as Net earnings divided by Average total assets by taking the average of the opening and closing asset balances for a period of time.read moreCalculate Net Credit SalesCalculate Net Credit SalesNet credit sales is the revenue generated from goods or services sold on credit excluding the sales discount, sales allowance and sales return. It even amounts to the accounts receivables for a certain accounting period.read moreIs Accounts Receivable Recorded as an Asset?Accounts Receivable TurnoverAccounts Receivable TurnoverAccounts Receivable turnover, also known as debtors turnover, estimates how many times a business collects the average accounts receivable per year and is used to evaluate the company’s effectiveness in providing a credit facility to its customers and timely collection. Accounts Receivable Turnover Ratio Formula = (Net Credit Sales) / (Average Accounts Receivable)read moreEquity Turnover Ratio Formula