In this article you'll:
- Learn what average collection period means
- Learn how to calculate your average collection period
- Find examples of average collection period by industry
- Learn how AR automation software can lower your average collection period
- And much more!
What is average collection period?
Your average collection period is the number of days between when a sale was made or a service was delivered and when you received payment for those goods or services. You may also know this as “Days Sales Outstanding” or DSO.
When your average collection period is low, this means you’re being paid within a reasonable amount of time after a sale was made or a service was delivered. Conversely, when your average collection period is high, this could signal potential cash flow problems as your business isn’t able to collect on receivables promptly.
It’s vital that your accounts receivable (AR) team closely monitor this metric and take action to keep it as low as possible.
How to calculate your average collection period
To calculate your average collection period, here are the steps you’ll need to follow.
You first need to know your average accounts receivable for the period you’re calculating.
To calculate your average accounts receivable, take the sum of your starting and ending receivables for a given period and divide this by two.
- Average Accounts Receivable = (Starting Receivables + Ending Receivables) / 2
You’ll also need your total net credit sales for this period. To calculate your total net credit sales, take your total sales made on credit for a given period and subtract any returns and sales allowances.
- Net Credit Sales = Sales on Credit − Returns and Sales Allowances
Now, you’ll divide your total net credit sales by your average AR balance for a given period. The quotient is what’s known as your accounts receivable turnover ratio.
- Accounts Receivable Turnover Ratio = Total Net Credit Sales / Average Accounts Receivable
Finally, you’ll take the number of days in the period you’re interested in calculating (365 days for example) and divide this by your AR turnover ratio. The resulting quotient is your average collection period.
- Average Collection Period = 365 Days / Accounts Receivable Turnover Ratio
You can also calculate your average collection period by dividing your average AR balance by your total net credit sales and multiplying the quotient by the number of days in the period.
- Average Collection Period = (Average Accounts Receivable / Total Net Credit Sales) ✕ 365
When assessing whether your average collection period is “good” or “bad” it’s important to take into account the number of days outlined in your credit terms. While at first glance a low average collection period may seem positive, it could also mean your credit terms are too strict.
Average collection period examples
Let’s say your annual sales are $25 million and your current receivables total $3.5 million. Your average collection period would be about 51 days. If you had terms of net 30 days, you would likely want to look for opportunities to enhance your collections processes such as with automation.
Doing so can significantly reduce your average collection period. However, if you offered 60-day terms to most clients, an average collection period of 51 would be pretty good and indicate that you’re clearly doing something right.
That said, there’s always room for improvement, and bringing the number down even further will certainly improve your cash flow and benefit your business.
In general, you want to keep your average collection period or DSO under 45 days. But, this number can vary by industry.
Here are a few median average collection period examples for various industries:
All Industries: 54
Business Services: 61
Industrial & Commercial Machinery and Computer Equipment: 67
Miscellaneous Manufacturing Industries: 68
Oil And Gas Extraction: 70
Real Estate: 30
Transportation Equipment: 57
Wholesale Trade (Durable Goods): 47
Wholesale Trade (Non-Durable Goods): 30
What is the importance of knowing your average collection period?
Your average collection period can help you understand many aspects of your business. The most immediate example is the health of your cash flow. If your average collection period is higher than you would like, this may signal challenges in unlocking working capital and hinder your business’ ability to meet its financial obligations.
A lengthy average collection period can also signal a negative customer experience. Slow collection times could result from a cumbersome billing and payment experience. It could also be a product of invoice disputes resulting from manual data entry errors or not giving customers transparency into their account.
How AR automation software can lower your average collection period
Once you understand what your average collection period is saying about your AR processes, what’s next?
Instead of carrying out your collections processes manually, you can take advantage of accounts receivable automation software. Even better, when you opt for an AR automation solution that prioritizes customer collaboration, you can improve collection times even further by streamlining the way you handle disputes and queries.
Here are a few of the ways Versapay’s collaborative AR automation software helps bring down your average collection period, improve cash flow, and boost working capital.
1. Automated invoicing
With an accounts receivable automation solution, you can automate tedious, time-consuming manual tasks within your AR workflow. For instance, with Versapay you can automatically send invoices once they’re generated in your ERP, getting them in your customers hands sooner and reducing the likelihood of invoice errors.
2. Zero-touch collections
Instead of having to remind your customers to pay with dunning letters and phone calls, you can deliver automated reminders before and after an invoice is due. In Versapay, you can segment customer accounts send personalized messages prompting your customers to remit payments on time. With this approach, you can better prevent accounts becoming delinquent.
3. Real-time communication
When disputes occur, there is often a string of back and forth phone calls that draw out the process of coming to an agreement and getting paid. Collaborative AR automation software lets you communicate directly with your customers in a shared cloud-based portal, helping you resolve these problems efficiently. When there’s an issue with an invoice, your customer can leave a comment directly on the invoice or proceed with a short payment and specify why.
4. Detailed reporting and customer management
To address your average collection period, you first need a reliable source of data. When you log in to Versapay, you get a clear dashboard of the current status of all your receivables. Your entire team can access your customers’ entire payment history, giving you a clear picture of your collection efforts. It’s the equivalent of a CRM for accountants.
5. Better customer experiences
With Versapay, your customers can make payments at their convenience through an online self-service portal. Today’s B2B customers want digital payment options and the ability to schedule automatic payments. With traditional accounts receivable processes, there’s a significant communication gap between AR departments and their customers’ AP departments. Make things easy by connecting with your customers using an intuitive, cloud-based portal that empowers them to pay when they want and however they want.
Learn more about how you can streamline your AR processes with intelligent collections here.
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