How to Get the Average Collection Period
Understanding the average collection period is crucial for businesses to manage their cash flow effectively. This metric helps in assessing how long it takes for a company to convert its receivables into cash. By calculating the average collection period, businesses can identify potential issues in their credit and collection processes, and take appropriate actions to improve their financial health. In this article, we will discuss the steps to calculate the average collection period and provide insights on how to optimize it.
Step 1: Gather the necessary data
To calculate the average collection period, you need to gather the following data:
1. Total accounts receivable (A/R) at the beginning of the period: This is the value of all outstanding invoices at the start of the period.
2. Total accounts receivable at the end of the period: This is the value of all outstanding invoices at the end of the period.
3. Net credit sales during the period: This is the total amount of credit sales made during the period, excluding any returns or discounts.
Step 2: Calculate the average accounts receivable
The average accounts receivable is calculated by taking the sum of the beginning and ending accounts receivable and dividing it by 2. The formula is as follows:
Average A/R = (Beginning A/R + Ending A/R) / 2
Step 3: Calculate the average collection period
Now that you have the average accounts receivable, you can calculate the average collection period using the following formula:
Average Collection Period = (Average A/R / Net Credit Sales) Number of Days in the Period
The number of days in the period is typically one year, but you can adjust it according to your specific needs.
Step 4: Analyze the results
Once you have calculated the average collection period, analyze the results to identify areas for improvement. If the average collection period is higher than the industry standard or your company’s target, it may indicate that you need to take action to speed up the collection process. Here are some strategies to consider:
1. Review your credit policies: Ensure that your credit policies are appropriate for your customers and that you are granting credit only to those who are most likely to pay on time.
2. Follow up on late payments: Implement a systematic follow-up process for late payments, including sending reminders and making phone calls to customers.
3. Offer incentives for early payments: Encourage customers to pay their invoices early by offering discounts or other incentives.
4. Monitor your accounts receivable aging report: Regularly review your accounts receivable aging report to identify any trends or patterns that may require attention.
Conclusion
Calculating the average collection period is an essential step in managing your business’s cash flow. By following the steps outlined in this article, you can gain valuable insights into your company’s credit and collection processes. Remember to analyze the results and take appropriate actions to optimize your average collection period and improve your financial health.
