In a business where sales are steady and the customer mix is unchanging, the average collection period should be quite consistent from period to period. Conversely, when sales and/or the mix of customers is changing dramatically, this measure can be expected to vary substantially over time. A company’s commitment to effective collection period management also contributes to overall economic stability. By ensuring their average collection period aligns with what’s reasonably expected within their sector, businesses can avoid contributing to cash flow problems and subsequent financial pressures.
The disadvantage of this is that it may suggest that the company’s loan terms are overly stringent. Stricter payment terms may result in customers fleeing to competitors with more forgiving payment terms. This includes anticipating a fall in economic conditions or not having adequate working capital to support the existing level of accounts receivable. There could be a decrease in financing for the collections department or an increase in worker turnover. In either situation, collections receive less attention, resulting in a rise in the quantity of receivables outstanding.
Enforce collection policies
In this article, we’ll show you how to calculate your company’s average collection period and give you some examples of how to use it. Accounts Receivables is defined as a business term to describe the customers which have purchased goods and services on credit from the organization. When bill payments are delayed, your cash reserve will deteriorate, and you will have low or zero access to funds. Discounts are always an enticing opportunity to increase sales and encourage customers to pay. If you discover shockingly high values when you calculate average collection period, you must work on ways to reduce them.
This industry will have a slightly longer collection period because the relationship between the supplier and buyer is built on mutual trust. Previously a Portfolio Manager for MDH Investment average collection period meaning Management, David has been with the firm for nearly a decade, serving as President since 2015. He has extensive experience in wealth management, investments and portfolio management.
Step 3. Calculate accounts receivable turnover ratio
In the following scenarios, you can see how the average collection period affects cash flow. The result above shows that your average collection period is approximately 91 days. Below you will find an example of how to calculate the average collection period.
- Subscription-based businesses expect to receive payments regularly, often on a monthly basis, leading to a shorter average collection period.
- The result above shows that your average collection period is approximately 91 days.
- It’s vital that your accounts receivable team closely monitor this metric and keep it as low as possible.
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- In the following example of the average collection period calculation, we’ll use two different methods.
- Liquidity is a financial measure of how instantly you can access cash for business expenses.
- Previously a Portfolio Manager for MDH Investment Management, David has been with the firm for nearly a decade, serving as President since 2015.
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