What Is Average Collection Period?

The Average Collection Period (ACP) is an average number of days between the day of a credit sale and the day the company receives the payment. In other words, it’s a number of days needed to convert receivables into cash.  

How to Calculate the Average Collection Period?

The formula to calculate the Average Collection Period is calculated by dividing 365 (number of days in a year) by Accounts Receivable Turnover Ratio.

Average\space Collection\space Period = \frac{365} {Accounts\space Receivable\space Turnover\space Ratio}

The Account Receivable Ratio measures the company’s effectiveness of collecting debts and extending credits. It’s calculated by dividing Net Credit Sales (from the income statement) by Average Accounts Receivable (from the balance sheet) for the period of time.

The higher the ratio’s value is, the better company collects their accounts receivable, which means their collecting methods are effective and company’s customers pay off their debts quickly. A lower value of the ratio indicates that collecting methods might not be as effective and fewer customers pay their bills on time.

Accounts\space Receivable\space Turnover\space Ratio = \frac{Net\space Credit\space Sales} {Average\space Accounts\space Receivable}

Knowing what Accounts Receivable Turnover Ratio is, the ACP formula can be rewritten as a number of days in a year × (Average Accounts Receivable ÷ Net Credit Sales).

Average\space Collection\space Period = 365\space \times\space \frac{Average\space Accounts\space Receivable} {Net\space Credit\space Sales}

In this example, the number of days in a period of time is 365 days. However, the number of days can be 360 (days per nominal accounting year) or any other period, as long as Net Credit Sales and Average Accounts Receivable span the same number of days. 

Example of an Average Collection Period Calculation

A company had Credit Sales of $1,630,000 and Accounts Receivable of $90,000 in 2017.

Credit Sales $1,630,000

Accounts Receivable $90,000

Average Collection Period = 365 × ($90,000 / $1,630,000) = 20,15 days

This means in 2017 the customers paid their credit every 20 days on average.

The next year the company’s Sales increased by $220,000 and the Accounts Receivable decreased by $10,000.

Credit Sales $1,850,000

Accounts Receivable $100,000

Average Collection Period = 365 × ($80,000 / $1,850,000) = 15,78 days

In 2018, ACP decreased to 16 days on average, which usually indicates that the company is collecting payments quicker. However, when the Average Collection Period is too short, it may mean the company’s credit terms are too strict and the customers may prefer another company with looser credit policy.

How to Use the Average Collection Period Formula

An Average Collection Period doesn’t have much valuable information as a standalone number. The best way to examine it is to compare ACP over time and look for a trend. The calculation may also be compared to other companies of a similar size and in the same industry. By creating a trend, we can see if there are any negative or positive changes.

What Do Average Collection Period Changes Mean

  • Collection efforts. A decrease in the ACP can mean that the company has decided to invest more funds, staff or technology in the collections department, which leads to the reduction of overdue Accounts Receivable. An increase in the Average Collection Period vice versa means that the company may have reduced funding of the collections department, so fewer customers pay on time.
  • Credit policy and collection terms. A decrease in the Average Collection Period indicates that a company possibly restricts the granting of credits to its customers for example because of not having enough working capital. It can also mean that the company has levied shorter payment terms. An increase, however, means that a company has decided to grant more credits or agrees for longer payment terms in order to increase sales.