Average Collection Period: Calculator, Examples, Ways to Improve

Key takeaways

• Average collection period determines short-term liquidity
• You calculate average collection period by taking the number of days in the period you’re interested in calculating and dividing this by your accounts receivable turnover ratio
• Average collection period can indicate how effective your accounts receivable management practices are
• A good average collection period is subjective, but generally, lower is better

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The quicker you can collect and convert your accounts receivable into cash, the better.

Enter: average collection period.

This is one of many accounts receivable KPIs we recommend tracking to better understand your AR performance. And while no single metric will give you full insight into the success—or lack of success—of your collections effort, average collection period is critical to determining short-term liquidity.

In this article, we’ll cover the following (jump to a section of interest):

• What average collection period is
• How to calculate average collection period
• Average collection period calculator [bookmark this!]
• Average collection period example
• Average collection period analysis
• How to improve average collection period

What is average collection period?

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. This metric determines short-term liquidity, which is how able your business is to pay its liabilities.

Average collection period is often used interchangeably with days sales outstanding (DSO). When interpreting the calculation, the general rule of thumb is:

• Low average collection period: your collections process is efficient, and you’re being paid within a reasonable amount of time after invoicing your customers
• High average collection period: your collections process is inefficient, which might signal impending cash flow challenges as you’re unable to collect on receivables promptly

It’s vital that your accounts receivable team closely monitor this metric and keep it as low as possible. We’ll discuss how to analyze average collection period further in this article.

How to calculate average collection period

The average collection period formula consists of 3 primary inputs:

• Average accounts receivable: This calculation looks at the average value of outstanding invoices paid over a defined period. It’s calculated by adding the amount of accounts receivable had at the start of an accounting period to the amount had at the end of that period. That sum is then divided by 2.
• Net credit sales: Your net credit sales are your total sales made on credit subtracted by any returns and sales allowances. This information should be readily available on your income statement or balance sheet.
• Accounts receivable turnover ratio (ARTR): Average collection period is most commonly designated as the number of days of a defined period divided by ARTR. ARTR measures the efficiency of your business’ collections efforts. It refers to how often you collect on your average accounts receivable during a given period.

To calculate your average collection period, here are the steps you’ll need to follow:

1. Calculate average accounts receivable
2. Calculate net credit sales
3. Calculate accounts receivable turnover ratio
4. Calculate average collection period
   

Step 1. Calculate average accounts receivable

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

Step 2. Calculate net credit sales

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

Step 3. Calculate accounts receivable turnover ratio

Now, you’ll divide your total net credit sales by your average accounts receivable balance for a given period.

• Accounts Receivable Turnover Ratio = Total Net Credit Sales / Average Accounts Receivable

Learn more about—and calculate—your accounts receivable turnover ratio.

Step 4. Calculate average collection period

Finally, to calculate average collection period for accounts receivable you’ll take the number of days in the period you’re interested in calculating (365 days in this example) and divide this by your accounts receivable turnover ratio. The result is your average collection period.

• Average Collection Period = 365 Days / Accounts Receivable Turnover Ratio

Alternatively, you can calculate your average collection period by dividing your average accounts receivable 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

Average collection period calculator

Using the interactive calculator below, we’ll calculate your average collection period. Simply input your values where prompted and we’ll handle the calculation!

Average collection period example

Now that you know how to calculate average collection period—and may have even calculated yours—let’s run through an example using the following inputs:

• Starting receivables — 500,000
• Ending receivables — 100,000
• Sales on credit — 5,000,000
• Returns and sales allowances — 1,000,000
• Period analyzed — 365 days
  

Assuming these values, you’d end up with the following:

• Average accounts receivable = (500,000 + 100,000) / 2 = 300,000
• Net credit sales = 5,000,000 – 1,000,000 = 4,000,000
• Accounts receivable turnover ratio = 4,000,000 / 300,000 = 13.33

Meaning your final result would be:

• Average collection period = 365 / 13.33 = 27.38

If your goal is to collect within 30 days, then an average collection period of 27.38 would signal efficiency. If your average collection period was significantly longer than your target collection terms, that’s indicative of a need to improve your collections efforts. There are many ways you can improve your processes, ranging from simple—such as using collections email templates—to more transformative—like investing in accounts receivable automation software.

Generally, you want to keep your average collection period or DSO under 45 days; however, this number can vary by industry.

Here are a few median average collection period examples for various industries:

• All Industries: 54
• Business Services: 61
• Communications: 64
• 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

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Interested in even more numbers to crunch? Check out this on-demand webinar featuring Versapay's CFO for insights on the crtical metrics you should be focusing on today.

Average collection period analysis

Average collection period is important as it shows how effective your accounts receivable management practices are. This is especially true for businesses who are reliant on receivables in respect to maintaining cash flow. Efficient management of this metric is necessary for businesses needing ample cash to fulfill their obligations.

Now, despite presenting as a single number, average collection period communicates more granular findings than just efficiency. You’ll benefit from knowing your average collection period because it:

• Informs how stringent—or lenient—your credit terms are
• Informs how well your competitors are performing: all average collection period inputs are available for publicly traded companies, meaning you can run this calculation for each competitor.
• Signals of receivables at risk of being uncollected
• Signals your business’ short-term financial health: poorer cash collections equate to higher risk of insolvency

What is a good average collection period?

When assessing whether your average collection period is good or bad, it’s important you consider the number of days outlined in your credit terms. While at first glance a low average collection period may indicate higher efficiency, it could also indicate a too strict credit policy.

What does a rising average collection period indicate?

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. An increase may also signal poor customer payment experiences. Slower collection times could result from clunky billing payment processes; or they might result from manual data entry errors or customers not being given adequate account transparency.

Increases to this metric might also mean:

• Your credit policies are too loose
• The economy is worsening
• Management is deprioritizing investment in collections

What does a decreasing average collection period indicate?

Beyond improved collections processes, decreases to this metric might mean:

• Your credit policies have tightened
• You’ve imposed shorter payment terms
• Management has prioritized investment in collections—and committed to transforming accounts receivable

How to improve average collection period

So, you understand what average collection period says about your AR processes. What 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 draws 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 collaborative payment portal that empowers them to pay when and how they want.

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Average collection period can inform you of how effective—or ineffective—your accounts receivable management practices are. It does so by helping you determine short-term liquidity, which is how able your business is to pay its liabilities.

Having this information readily available is crucial to operating a successful business. However, we recommend tracking a series of accounts receivable KPIs and to develop a system of reporting to more accurately—and repeatedly—gauge performance. Not all metrics work for all businesses, so having an abundance of performance indicators is more valuable than relying on a single number.

Here are a few extra KPIs to track:

• Accounts receivable turnover ratio
• Days sales outstanding
• Collection effectiveness index

PS—we’ve included interactive calculators at each of those links above.

Learn how you can identify and interpret the AR KPIs that really count, with the Accounts Receivable Performance Toolkit.