Average Collection Period: Overview, Formula & Example

In the business world, it’s important to make sure you pay your bills.

Not only that, but make sure that you pay your bills in full, and in time.

Whenever you have bills that you’re scheduled to pay, it’s important to keep track of how much you owe. You should always be monitoring your cash solvency so that you are sure you have enough capital available to take care of your financial responsibilities.

That’s where the average collection period comes into play.

But what exactly is the average collection period? We’ll take a closer look at the definition, the formula, and give you an example of the ACP in play.

Here’s What We’ll Cover:

What Is the Average Collection Period?

What Is the Average Collection Period Formula?

Why Is the Average Collection Period Important?

Key Takeaways

What Is the Average Collection Period?

The average collection period, or ACP, refers to the amount of time it takes for a business to receive any payments that it is owed by its clients. This is in terms of accounts receivable, or AR.

A company would use the ACP to ensure that they have enough cash available to meet their upcoming financial obligations.

This method is used as an indicator of the effectiveness of a business’s AR management and average accounts. It is one of the many vital accounting metrics for any company that relies on receivables to maintain a healthy cash flow.

The ACP is a calculation of the average number of days between the date credit sales are made, and the date that the buyer pays their obligation.

What Is the Average Collection Period Formula?

The ACP is generally calculated in days. So in order to figure out your ACP, you have to calculate the average balance of accounts receivable for the year, then divide it by the total net sales for the year.

The formula for calculating the ACP is as follows:

Average Collection Period = Accounts Receivable BalanceTotal Net Sales x 365

Let’s look at an example. Let’s say that your small business recorded a year’s accounts receivable balance of $25,000.

In the same year, your company also logged $200,000 in total net sales.

So the first step to figuring out your average collection period is to divide your AR by your net sales. You would then have to multiply the result by 365 due to the fact that you’re trying to determine the average collection period for the year:

25,000200,000 x 365 = 45.6

This would show that your average collection period ratio of the year is around 46 days. Most businesses would aim for a lower average collection period due to the fact that most companies collect payments within 30 days.

As a business owner, the average collection period figure can tell you a few things.

It may mean that your business isn’t efficient enough when it comes to staying on top of collecting its accounts receivable. However, it can also show that your credit policy is one that offers more flexible credit terms.

Why Is the Average Collection Period Important?

There are two main points to consider when talking about the importance of the ACP. They are:

Maintaining Liquidity

It’s vital for companies to receive payment for goods or services in a timely manner. It allows the business to maintain a good level of liquidity which allows it to pay for immediate expenses. It also allows the business to get a good idea of when it may be able to make larger, more important purchases.

Planning for Future Costs

The ACP figure is also a good way to help businesses prepare an effective financial plan. You can consider things such as covering costs and scheduling potential expenses in order to facilitate growth.

Key Takeaways

The average collection period is an important metric to consider when looking at your business.

For obvious reasons, the lower the ACP is, the better it is for your business. It means that your clients take a shorter period of time to pay their bills and you have less uncertainty about payment times.

Are you looking for more business advice on everything from starting a new business to new business practices?

Then check out the FreshBooks Resource Hub.

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