Average Collection Period Definition, Example and Analysis
Average collection period Definition – “Average collection period is the time period between the credit sale and the payment received for the same”.
This financial ratio indicates the capability of a firm to collect its accounts receivable. Accounts receivable is the money that the customers owe to the company. Business firms always tries to keep their average collection period short. This implies that organizations are recovering their money very early which is good for them.
Early recovery of the accounts receivable results in increasing the liquidity of the firm and meeting the short term obligations of the firm. This ratio is expressed in term of the days.
Average collection period = (Average accounts Receivables / Sales Revenue) × 365
Average Collection Period Example
Let’s understand the average collection period definition with the help of an example –
Following is the data from the books of accounts of ABC Ltd.
Total Sales – 1,00,000
Cash Sales – 50,000
Accounts receivables (closing balance ) – 15,000
Accounts receivables (opening balance) – 8,000
Average accounts receivable = (15,000 + 8,000)/ 2
Therefore, average collection period = (11,500/1,00,000) × 365
= 42 days
Average Collection Period Analysis
The shorter collection period indicates that, firm is recovering the accounts receivables early and there is management of receivables. This also implies that, if any short term obligation arises, firm can easily pay off their obligations.
On the other hand, if the collection period is larger, this means that firm is unable in collecting the receivables timely or taking longer time. When the obligations to pay comes, firm won’t be able to fulfill their short term liabilities.